The year 2023 could be dubbed as the year of interest rate hikes, with major central banks around the world engaging in a series of consecutive borrowing cost increases in an effort to curb high inflation.
On the contrary, it is likely that those banks might start lowering interest rates this year. Indeed, many officials spoke about this at the World Economic Forum held in Davos last week, expressing a preference for waiting and moving cautiously instead of altering their course.
Federal Reserve
The Federal Reserve is probably in the best position, ahead of its rates decision on January 31, because inflation is moderating without an economic downturn.
There will be no explicit policy change and the main focus will be the signals sent by the Federal Open Market Committee regarding the speed and number of interest rate cuts to come this year.
Financial markets have expected the first cut in March and five further reductions in 2024.
Markets are beginning to take note. Accordingly, the CME Group FedWatch Tool now has a less than 50 per cent financial market expectation of a March rate cut.
Meanwhile, the FOMC’s economic projections from December suggested only three quarter-point rate cuts were likely.
The key issue is that Fed governors want evidence if they are to cut rates faster or more extensively. This would require inflation falling more rapidly and sustainably than expected or some bad news on jobs from the labor market.
European Central Bank
Lagarde said she wanted to avoid cutting rates too early, but she also said that it was reasonable to think the central bank would cut its rates by the summer if there was not a further inflationary shock.
Previously, her blanket response was that it was far too early even to talk about rate cuts, so her new statements were an acknowledgment that policy priorities are shifting in Frankfurt.
The key reason for the delay was to give the ECB time get sufficient evidence in late spring that high wage growth did not present a continued inflationary threat.
The eurozone does not have a comprehensive, accurate and timely measure of wages, but they are growing much faster than a rate consistent with the inflation target.
Bank of England
The BoE has the biggest task ahead in its meeting on Feb. 1.
It needs an entirely new economic narrative to accompany its refreshed economic forecasts that are bound to change significantly.
With inflation in the fourth quarter of 2023 much lower than expected and energy prices well down on the Monetary Policy Committee’s November forecast assumptions, CPI inflation is now likely to fall back to the BoE’s 2 per cent target in the April or May data this year. In the November forecasts, the MPC thought it would achieve this milestone only at the end of 2025.
Bank of Japan
The Bank of Japan is different in two respects. It is considering an interest rate rise rather than cuts and has already finished its meeting.
Contrary to many economists’ predictions last autumn, the BoJ again left interest rates at -0.1% and did not signal an imminent end to its policy of negative interest rates. It also left yield curve control unchanged.
The main reason for the BoJ’s caution is that inflation and wage growth data have been weaker than expected, casting doubt on the BoJ’s ability to hit a 2% target sustainably.
The Committee still expressed confidence that after weaker energy prices lowered inflation in the 2024 fiscal year, a “virtuous cycle” between wages and prices would emerge, ensuring inflation would stabilize around the 2% target rather than falling below.
A symbolic rate rise to zero per cent in April is still expected, but it is a close call and will depend heavily on wage data in the coming months.