Central banks’ hawkish downshift

We expect central banks to slow the pace of tightening but hint at higher terminal rates.

Major central banks meeting next week each face different macroeconomic conditions but a similar challenge. They will need to balance the need for a more gradual approach, following one of the fastest monetary tightening cycles in history, with lingering inflation risks, including growing concerns over wage growth and second-round effects.

We expect the Federal Reserve (Fed), the European Central Bank (ECB), the Bank of England (BoE) and the Swiss National Bank (SNB) to hike their policy rates by 50 basis points (bps) next week. Their communications should remain hawkish, consistent with higher terminal rates and no early rate cuts.

On 14 December, we expect the Federal Reserve to raise rates by 50bps (in line with market consensus), a smaller increment than the +75bps rises at previous meetings. This should push the fed funds target range to 4.25-4.50%. We expect communication to stay hawkish as we do not think Fed chairman Jerome Powell will lower his guard on inflation and will likely highlight the risk a still-tight labour market fuelling a wage-price spiral. Powell is likely to stress that the bar to cutting interest rates will be high in 2023 given the high current level of inflation (the headline consumer price index was 7.7% year-on-year in October). Keeping a restrictive stance for longer would go against current market pricing of a slide in the fed funds rate to around 4.5% by end 2023.

We expect the ECB to hike the deposit rate by 50bps at its 15 December meeting, following two consecutive 75bps hikes. This would bring it to 2%, close to the estimated neutral rate. Our forecast for 2023 is for the ECB to deliver two additional 25bps hikes, one in February the other in March, but with the possibility of higher rate increases. We expect the ECB to present the broad outlines of its plans for quantitative tightening. 

The BoE looks likely to prioritise the fight against inflation over economic pain even though the UK economy has likely entered recession already. On 15 December, we expect it to hike by 50bps, pushing the bank rate to 3.5%. We continue to think that the Bank of England could end up hiking interest rates to 4.75% by May, especially given the risk of another inflation shock from the April 2023 utility bills hike. 

Following rate hikes of 50bp in June and 75bp in September, we expect the SNB to raise its main policy rate by 50bp to 1.0% net week. The language in the policy statement is expected to remain fairly unchanged from September. The SNB is likely to keep open the possibility of further rate hikes at coming meetings and signal that it is too early to let the Swiss franc weaken.

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