- The Fed, BoE and ECB all raised rates by 50bps this week, following 75bps hikes in previous meetings.
- In November, US inflation fell to 7.1%, UK inflation dropped to 10.7% and eurozone CPI fell to 10.6%, after months of rising prices.
The US Federal Reserve, Bank of England and European Central Bank all raised rates again this week, but with data pointing to a cooling of inflation, all three central banks opted to slow the pace of tightening, pointing to a new phase in monetary policy.
The Fed raised its benchmark policy rate by 50bps on Wednesday – a step down in the pace of hikes after four successive 75bps rises – increasing the federal funds rate to a target range of 4.25-4.5%1 .
On Thursday the Bank of England (BoE) raised its base rate by 50bps – down from 75bps in November – to 3.5%2, while the European Central Bank (ECB) also raised rates by 50bps – following two 75bps hikes – increasing its deposit rate to 2%3.
The banks’ pivot towards smaller rate rises comes against a backdrop of cooling inflation. US consumer price inflation fell to 7.1% in November, down from 7.7% in October, and has now fallen for five consecutive months4. Inflation in the UK and eurozone also fell in November – dropping to 10.7% in the UK and 10.6% in the eurozone – after months of soaring prices.
Developed markets inflation starts to dip
Despite expectations that inflation may have peaked in all three regions, central bank governors struck a notably hawkish tone in their statements.
“Fed Chair Jay Powell pushed back against markets extrapolating an imminent dovish pivot, stressing that the Fed has still work to do in its fight against inflation and highlighting the inflationary risks from a tight labour market,” says Silvia Dall’Angelo, Senior Economist at Federated Hermes Limited. “However, Powell also offered some tempering dovish hints, suggesting that the Fed is close to peak rates and openly implying that a further downshift to a 25bps rate hike is on the table for the next meeting in February.”
Lewis Grant, Senior Portfolio Manager at Federated Hermes Limited, points out the Fed has no choice but to engage in a game of four-dimensional chess with the market because the threat of rate rises is as crucial a tool in combatting inflation as rate rises themselves. “We are likely closer to an inflection point than the Fed are indicating, however predicting these things reliably is often a fool’s errand. Taking a long-term position and trying to ignore short-term noise tends to be a winning strategy for those who can avoid impulsive overreactions,” he says.
Despite the slowdown in interest rate rises, European stocks closed down on Thursday with the regional Stoxx Europe 600 tumbling 2.85%5. In a press conference following the policy announcement, ECB president Christine Lagarde suggested 50bps hikes could continue for some of time, which may have had an impact on market sentiment. The UK FTSE 100 fell 0.93%.
The yield on the 10-year German government bond had risen 2.08% on Thursday at 16:30 while the yield on the 10-year Italian bond hit 4.1%.
In the US, the US blue-chip S&P 500 closed down 0.61% and the tech-heavy Nasdaq Composite dipped 0.76% on Wednesday.
“In this recessionary environment, with war in Ukraine and elevated geopolitical tensions, with Covid spreading throughout China, with the UK facing a winter of strikes and a cold spell in Europe coupled with the insufficient wind to drive the turbines, we must look to the long-term for optimism,” Grant adds.
We are likely closer to an inflection point than the Fed are indicating
“This week has seen incredible scientific news, with promising early results from experiments in fusion power and positive trials of cancer vaccines. We are reminded of and uplifted by humanity’s capability for discovery and for tackling some of our most pressing challenges,” Grant says.
“This type of innovation is not always immediately relevant for investors, however, after a year in which growth stocks have been universally shunned and companies generating revenue from activities aligned to resolving the UN Sustainable Development Goals now trade at a discount to their peers. These are tomorrow’s growth stocks, and their depleted valuations present a compelling opportunity for the long-term investor.”
To learn how investors might position themselves for a fall in inflation read our Spectrum, Q4 2022 report.
4 Bloomberg as at 15 December
5 Bloomberg as at 15 December