The Fed's hiking cycle is probably done; the BoE's too, but it could yet spring one more 25bps hike.
No surprises from the Fed last night, as the FOMC voted to keep interest rates on hold for the second month in succession. But there was a noticeable shift in the language, with Powell making reference to the tighter financial conditions currently being experienced in the US - the consequence of the surge in yields that has been seen over the last quarter or so - which is expected to weigh on economic activity going forward, effectively doing the Fed’s work for it.
By explicitly acknowledging the dampening effect of higher yields, Powell effectively left the door open for the FOMC to pause again in December and skip the rate hike that is implied by September’s dot plot. But the overall language on Fed policy going forward was left unchanged. It will continue to take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments, when determining whether or not any further tightening in policy is required to ensure that CPI returns to its 2% target. Clearly this means that no firm decision on December’s meeting has yet been taken, meaning it will be a ‘live’ meeting. This means that data releases between now and then will be key in determining December’s outcome, most importantly the CPI and employment data. But with Powell noting yesterday that job gains have “moderated” since the start of the year, potentially removing a large impediment to a softer stance, the market has put everything together and concluded that the Fed has now likely finished the current hiking cycle, and has reacted accordingly with equities trading higher and yields lower.
But a note of caution needs to be made. Given how the Fed got the ‘transitory’ inflation argument so wrong, Powell will not take any chances with CPI this time around, and will not therefore indicate that the current hiking cycle has definitely finished until CPI is virtually back to target or that economic data makes maintaining the current position untenable. As such, although we do not envisage rates being raised any higher, it may well be at least Q2 2024 before any meaningful easing is delivered.
Attention for today now turns to the BoE, where a similar decision to keep interest rates on hold is expected. However, the decision will be much closer than that faced by the FOMC yesterday, given that inflationary pressures in the UK are considerably higher than in the US and growth significantly weaker. The decision to keep rates on hold in September was secured with a vote of 5-4, ie the narrowest possible margin. Data releases since then suggest it will be difficult for the 5 MPC members who voted to keep rates on hold then to shift position and vote for an increase today: labour market data is continuing to point to a slackening in labour demand and slowing wages growth, while growth figures remain precariously soft. However, October’s CPI numbers showed inflationary pressures to be very ‘sticky’ and, in similar fashion to the Fed, the BoE will be taking no chances with inflation having also got the ‘transitory’ inflation argument so wrong. There is a similar credibility rebuilding exercise going on at the BoE as there is at the Fed which could just be enough to persuade a majority of MPC members that one more 25bps hike is required before they can comfortably bring the current hiking cycle to a close.
In summary therefore, the Fed is most likely done with further interest rate hikes; and the BoE probably too. But the latter might yet throw in one more 25bps hike to be sure that CPI remains on a downwards trajectory.