- The US central bank’s pause from hiking rates should allow it to judge whether the fastest tightening cycle in 40 years has been sufficient to restrain inflation.
- Amid growing concerns that China’s post-Covid recovery is stalling, the PBoC trimmed its medium-term lending facility rate to 2.65%.
The divergence in global monetary policy was in evidence this week, as the US Federal Reserve paused its rate hikes, the European Central Bank (ECB) raised rates to their highest level in 22 years, and the People’s Bank of China (PBoC) cut its main policy rate for the first time in 10 months.
On Wednesday, the Fed announced a temporary halt in tightening, leaving rates at 5% to 5.25% after more than a year of consecutive rises1. The move marks a shift in how the US central bank views inflation as consumer price rises fell to 4% in May, the lowest level since March 20212.
Meanwhile, on Thursday, the ECB raised its benchmark deposit rate by 25bps to 3.5%, warning that inflation remains a pressing concern3. Consumer prices in the eurozone rose 6.1% in the year to May, a decline from 7% in April4. However, the ECB does not expect inflation to return to its 2% target for another two years.
We see easing in China as a positive step
In China, the PBoC reduced its medium-term lending facility rate, a one-year rate that influences bank funding costs, to 2.65% (from 2.75%) on Thursday5, as new data added to concerns that the post-Covid recovery in the world’s second-largest economy was stalling.
“The much-expected pause in US rate hikes ultimately did little to move the indices, but China’s surprise rate cut has been well-received by investors,” says Lewis Grant, Senior Portfolio Manager for Global Equities at Federated Hermes Limited.
The US blue-chip S&P 500 Index ended Wednesday 0.08% higher, marking its fifth consecutive positive session. Hong Kong’s Hang Seng Index closed up 2.2% higher on Thursday, following the PBoC cut, while the pan-Europe Euro Stoxx 50 Index closed down 0.25%6.
“While we have concerns about the Sino-US geopolitical risk, the global economy has been reliant on Chinese growth and any untangling of that, without causing serious harm, will take time. We see easing in China as a positive step towards unravelling the global inflationary environment but do not expect the effects to filter to Western economies for a few a months,” Grant adds.
A ‘hawkish’ pause
The Fed’s pause from hiking rates – after 10 straight increases dating back to March of last year – should give the US central bank time to judge whether or not the fastest tightening cycle in 40 years has been sufficiently restrictive to dampen aggregate demand and restrain inflation, says Donald Ellenberger, Head of the Multi-Sector Strategies Group at Federated Hermes.
Figure 1: Implied Fed funds target rate
The ‘dot plot’ of individual interest rate projections suggests Federal Open Market Committee (FOMC) members believe a bit more tightening may be necessary to return inflation to the Fed’s 2% target, although it would depend on inflation and labour market data. Fed policymakers forecast the median rate at year-end to be 5.6%, compared to the projection of 5.1% a little more than a month ago. Twelve of 18 FOMC members now anticipate at least two more 25pbs hikes this year.
Elsewhere, the US median unemployment rate forecast was revised down from 4.5% to 4.1% by the end of 2023, according to the Fed’s summary of economic projections, while the core inflation rate was revised up from 3.6% to 3.9%7, providing the rationale for two more hikes this year.
“Fed Chair Jay Powell was careful to emphasise that no decision was made on a July hike, but he did say it is a live meeting, leading the market to increase the probability of a move,” Ellenberger adds.
For further insights on China, please see our recent video Crouching tiger: the contrarian case for China
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1 Federal Reserve skips rate rise but signals two more increases on the way | Financial Times (ft.com)
2 CPI report May 2023: Inflation rose at a 4% annual rate in May, the lowest in 2 years (cnbc.com)
3 ECB increases interest rates to highest level since 2001 | Financial Times (ft.com)
4 Eurozone Inflation Rate Falls to 6.1 Percent in May – The New York Times (nytimes.com)
5 China Central Bank PBOC Ramps Up Policy Action With 1-Year Rate Cut – Bloomberg
6 Bloomberg as at 15 June.
7 Summary of Economic Projections, June 14, 2023 (federalreserve.gov)
