Interest rate raises are certain in the coming week from the Bank of England, US Federal Reserve and European Central Bank, with speculation alive about not only the size of the three hikes and the tone of guidance about coming months.
Up first is the Fed on Wednesday, the first day of the new month after recent declines in inflation have increased the probability of a further reduction in the size of the US central bank’s rate hikes to 25bps in February from 50 bps in December.
Based on the fading momentum of inflation, the FOMC is likely to press pause after this, said Philip Marey, Rabobank’s senior US strategist.
“Given the long and variable lags of monetary policy, the decline in inflation, and the weakening economy, we think that after a second 25 bps hike in March it is time to keep policy rates constant and assess the impact of the hiking cycle so far.
“If the loss of momentum in inflation continues in the coming months, a rate hike by May 2 looks overdone in our view.”
A contrasting view is that Fed head Jerome Powell is “likely” to hint at the significant chance of another rate hike ahead, said Nikko AM's chief global strategist John Vail.
“The Fed is likely watching gasoline prices rise with some concern, and may wish to see if December’s weak macro data was greatly weather-related (given the rebound in January’s macro data), but it has plenty of time before the next meeting to absorb the various macro data required to make March’s decision.
“It will, however, likely continue to push back on expectations of rate cuts later this year.”
Tough act to follow, but the Bank of England is used to being the support act on Thursdays.
And after being more cautious than its transatlantic cousin in terms of increasing rates and tightening measures, from 0.25% to 3.50% last year, but this time it will go further, with a second consecutive 50bps hike to 4.0%.
Similar to the December meeting, there is expected to be a split of opinions on the monetary policy committee (MPC) due to mixed signals on the inflation outlook, said UBS.
“On the one hand, the incoming data since the last meeting signals better-than-expected activity in Q4, a cooling but still tight labour market, and sticky core inflation, which is likely to reinforce concerns amongst the more hawkish MPC members about inflation persistence,” said economist Anna Titareva.
“On the other hand, a sharp drop in gas prices (down 44% compared to December average) implies that if gas prices were to stabilise at current levels, retail gas and electricity prices could start falling in H2, and bring inflation down faster than the MPC previously expected, as was recently acknowledged by Governor Bailey.”
Overall, economists expects the MPC make a couple of quarter-point hikes to a peak of 4.50%, though bond markets are sceptical of that, with the two-year UK gilt yield currently at 3.46%.
“This yield has a history of leading the Bank of England Base Rate by six to nine months, which suggests that the bond markets think rates may peak and then be cut sooner than expected,” said AJ Bell investment director Russ Mould.
Capital Economics’ Paul Dales sees rates subsequently rising to 4.50% but thinks “markets will be surprised by how fast interest rates are cut in 2024”.
Over at the ECB the past week has seen policymakers working hard to play down suggestions they may pivot to smaller hikes of 25 basis points due to the more encouraging macroeconomic data emanating from the continent.
A rate hike of 50bp looks like a done deal, as a result but communication will be crucial, said Carsten Brzeski, global head of macro at ING, as “how far and how fast the ECB will go from there, is still unclear”.
“We expect hawkish comments by ECB President Christine Lagarde in order to prevent another drop in market interest rates. In this regard, it would help if the ECB were to clarify its reaction function and send a message that has a longer shelf life than just a few days.”
Macro matters
A new month begins on Wednesday so that brings a new round of macroeconomic data, with the US jobs report on Friday the main event.
The non-farm payrolls number, which always has “all eyes” on it, saw 223k new jobs added in December, with the unemployment rate falling to 3.5% from 3.6%, average hourly earnings growth came in below expectations at 4.6% and the previous month’s numbers were revised down to 4.8%.
January is expected to have seen 175k new jobs added, with the unemployment rate set to edge back up to 3.6%.
“There continues to be a sense that the market is becoming complacent about how quickly we might see the Federal Reserve pivot when it comes to interest rates, however while the unemployment rate remains at multi year lows the US central bank has little incentive to cut rates when inflation still remains almost 3 times higher than its 2% target,” said market analyst Michael Hewson at CMC Markets.
EU inflation and jobs data is also out on Wednesday, a day ahead of the ECB meeting.
Wednesday also sees January’s PMI manufacturing indices for the UK and other major economies, though for the US the ISM manufacturing gets more attention later in the day.
There’s also UK retail data from BRC, MBA mortgage applications and US construction spending.