Matterhorn or Table Mountain? Central Banks Mull the Rate Hike Summit

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Eurozone Market Update

In September, the ECB delivered its tenth consecutive rate hike since 2022, raising its key interest rates by 25 bps and taking the deposit facility rate to 4%. Markets interpreted this as the bank having reached the summit of its rate hikes cycle, at least for now, as supplementary ECB commentary stated that policy rates are now set at a sufficiently restrictive level. Updated ECB projections for average headline inflation showed an upward revision in 2023 (5.6%) and 2024 (3.2%), mainly to reflect higher energy prices, but revised down the 2025 number to 2.1%. We think this leaves the door open for further rate hikes if inflation reaccelerates. Last month, headline eurozone inflation dropped from 5.2% to 4.3% (see Chart of the Month), while core inflation also fell (from 5.3% to 4.5%). Quarterly GDP (0.1%) missed expectations, reflecting Europe’s stagnating economic activity. This led the ECB to revise down their growth projections to 0.7% in 2023, 1.0% in 2024 and 1.5% in 2025.

Euro Short Term Rates

_{Source: Bloomberg, data as of 29 September 2023}

UK Market Update

Following fourteen successive rate hikes, September saw the BoE’s Monetary Policy Committee (MPC) vote 5-4 to pause its hiking cycle, with Governor Andrew Bailey casting the deciding vote. Therefore, the bank rate remained unchanged at 5.25%. The day before the vote, UK annual inflation data came in well below market expectations, with headline inflation printing at 6.7% versus 7.0% expected, and core inflation printing at 6.2% versus 6.8% expected. This provided a clear signal to the BoE that they should indeed follow the alternative path of having a lower peak rate for a prolonged period, as opposed to a sharp move up in rates followed by a similarly swift cut. The BoE kept its forward guidance unchanged, repeating that “further tightening in monetary policy would be required if there were evidence of more persistent inflationary pressures.” The MPC’s updated projections highlighted further signs of loosening in the labour market. At the same time, inflation should return to the 2% target by Q2 2025, though this is far from a given.

GBP Short Term Rates

_{Source: Bloomberg, data as of 29 September 2023}

US Market Update

The Federal Open Market Committee (FOMC) voted to maintain the Fed Funds target range between 5.25% to 5.50% in September. While the markets broadly expected this pause, the Fed doubled down on its mantra that interest rates will remain higher for longer, with its updated projections suggesting that the economy will enjoy the “softest of soft landings.” However, despite recent favourable inflation news, most policymakers still see one more hike in 2023 as appropriate. The FOMC’s economic projections showed a 50 bps upward revision for the interest rate in 2024 and 2025, and the equivalent of two 25 bps cuts next year. The US labour market is now approaching pre-pandemic norms, While the Institute for the Supply Management manufacturing index registered 49.0, still signalling contraction, it is up from a six-month high of 47.6 in August, suggesting a positive trend.

USD Short Term Rates

_{Source: Bloomberg, data as of 29 September 2023}

Looking Ahead

The actions of the three central banks suggest that perhaps we have reached the summit of this hiking cycle or are at least on the final ascent. The debate now shifts towards what the shape of the mountain top looks like - Matterhorn or Table Mountain? Matterhorn implies a sharp move up in rates followed by a similar move down. However, the Fed, ECB and BoE have made it abundantly clear that they prefer the flat top of Table Mountain. All three have used forward guidance to deliver this message to the market. The BoE's pause should not be interpreted as a premature declaration of victory on inflation. The risk that it hikes to 5.5% is not a small one. Both the Fed and ECB will have a more balanced approach, relying on backward-looking data (notably inflation) and forward-looking growth indicators. Importantly, neither has shut the door on further rate hikes, as inflation projections remain above their 2% target in the medium term, but as things stand, there is a strong likelihood that this was the final hike of the cycle.

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