Central banks took centre stage this week, with interest being set both in the US and here in the UK. The Federal Reserve were the first to the table, where they increased rates by 0.75%. This was in line with expectations, but some market commentators had touted a full 1% rise, a move adopted by Sweden earlier in the week. This takes US rates to the 3%-3.25% range.

This move is unlikely to be the last, with the central bank reiterating that “we have got to get inflation behind us.” This was confirmed in the latest Fed dot plot, which shows the projections for interest rates from the individual committee members.

The median expectation for the end of 2022 is now a little over 4.25%, which is pretty much in line with market expectations as expressed through futures. The median expectation for 2023 meanwhile is in excess of 4.5%, suggesting the Fed may need next year as well to complete their task. The market however continues to have a different view, expecting a rate of somewhere between 4% and 4.25%, in the expectation that the Fed will be forced to adopt a more dovish stance in order to try and protect against an aggressive economic contraction. The outlook further out is a lot more clouded and this is reflected in the individual projections, with one member forecasting a rate of just over 2.5% whilst others still expect to see rates over 4.5%. A median therefore of circa 3.75% does not appear to have much relevance at present.

The Bank of England also hiked in line with market expectations, increasing by 0.5% to 2.25%, representing the seventh consecutive rate hike and the highest level of rates seen since 2008. As in the US, some thought that the central bank could be more aggressive with a 0.75%. The division of thought amongst market commentators was also seen within Monetary Policy Committee members. Opinion was the most divergent seen in some time, with five members voting for a 0.5% increase, three for 0.75% and one for 0.25%. The Bank now see UK inflation peaking at around 11% instead of their previous estimate of 13%, due to the government’s energy support package. In a fast moving world, this could again be subject to, especially once the latest announcements by the Chancellor are subjected to analysis and their potential impact is quantified.

The latest market interest rate expectations see the UK base rate peaking at 4.5% mid 2023. This compares to the August forecast 2.75%, representing a substantial change. With tackling inflation the number one priority, growth expectations continue to dwindle. The latest Atlanta Fed GDPNow estimate for the third quarter now stands at only 0.3%. The latest economic forecasts for 2023 for the US, Euro area and UK also paint a pessimistic picture. Expectations amongst economists surveyed by Bloomberg show an average projection for growth in the US of just under 1%, Euro area 0.5% and the UK economy in contraction.

For how long will central banks keep their foot to the floor in terms of interest rate hikes?

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