When will central banks stop hiking rates?

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Key takeaways

This is a big week for central bank watchers. On Wednesday we have the Federal Reserve and on Thursday the Bank of England (BoE). Both are expected to raise official rates by 75 bps, following a similar move by the ECB last week.

2022 is witnessing the most aggressive coordinated tightening move by central banks in decades. So, the question arises: when will it all end? The answer – when they feel that they have got on top of inflation, which in turn depends on the respective economies.

The US labour market remains drum tight

Let’s begin with the most important economy of all: the US. There is a strange combination of economic forces here. Look for weakness and you can see it in GDP – the broadest measure of economic activity. Yes, it grew in the third quarter of 2022 but that followed two quarters of contraction. There’s a real recession in the housing market where both activity and prices are plunging. Economic survey data is tumbling but this is offset by the strength of the labour market where every indicator there is showing that it is drum tight. Low unemployment means rising wages and rising rents – the two most powerful and persistent sources of inflation in the US. On Friday we get the October jobs report and until we get a negative jobs update, the pressure will be on the Federal Reserve to keep on hiking.

A recession is needed to bring US inflation down

It is our long-held view that a recession is required to bring US inflation down. And that will involve a cut in profit margins and a fall in earnings. We are in the Q3 reporting season and the overall picture is that companies se already struggling to match analysts’ expectations. The outlook for earnings is not good. Investors, however, are expecting updates to be disappointing.

European inflation worries

German rose to 11.6% in October, which was way above expectations. The European Central Bank faces a weakening economy and high inflation – an unpleasant cocktail for a central bank.

Fiscal uncertainty in the UK

Meanwhile back in the UK, the BoE must act against a background of fiscal uncertainty. We think they’ll take the easy course and raise rates in line with the consensus – 75 bps. But the economy here is already struggling and the sudden rise in mortgage rates will take further heat out of the spending. Rates remain low, even if the BoE do push them up to 3% as we expect, the era of ultra-low interest rates is behind us. And that doesn’t bode well for the housing market.

Optimism for 2023

It’s a tough background for the economy and for risk assets but we observe that equities have already fallen a long way and investors are expecting economic weakness. There may well be a further sell off in risk assets and that may continue into 2023 but that could be a buying opportunity.

Steven Bell

Chief Economist, EMEA

Risk disclaimer

The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

Views and opinions expressed by individual authors do not necessarily represent those of Columbia Threadneedle.

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