Monetary policy: Central bank week

There are three key interest rate decisions this week. Even if the big central banks continue to tighten the reins, they will slow down.

A few days before the economy and financial markets enter their Christmas quiet phase, the hour of monetary policy strikes once again. With the US Federal Reserve (Fed), the European Central Bank (ECB) and the Bank of England (BoE), three heavyweights are announcing their interest rate decisions this week and will – almost more importantly – make important statements about their future monetary policy actions .

Their final message of the year is already clear: monetary policymakers on both sides of the Atlantic will reaffirm their unwavering determination to continue fighting inflation. The forthcoming next rate hike – by the Fed today, by the ECB and BoE tomorrow, Thursday – also shows a certain unanimity: the markets expect further rate hikes of half a percentage point from all three players.

However, this largely exhausts the similarities. The Bank of England is in a special situation given the significant post-Brexit turmoil. After aggressively raising interest rates by almost 300 basis points to three percent, the monetary watchdogs have recently pointed out the gloomy outlook for the British economy, which makes a slower pace likely in the coming year as well.

Fed slows pace

After four maximum interest rate hikes of 75 basis points, the Fed is likely to slow down somewhat and start the new year with a key interest rate of 4.25 to 4.50 percent. “However, the only slow slowdown in the labor market and the ongoing pressure on wages increase the likelihood that the Fed will continue to hike interest rates in the coming year,” commented Julius Baer’s economists.

The markets are now assuming that the US key interest rate will peak at 5.00 percent. According to bond expert Franck Dixmier from Allianz Global Investors, market participants were even expecting a first interest rate cut in the second half of 2023. Dixmier himself, on the other hand, warns of inflation surprises and sees the interest rate peak in the USA between 5.00 and 6.00 percent. In addition, he does not expect a rate cut in the coming year.

Pressure on the ECB even stronger

The markets are unanimous in expecting the ECB to slow down its rate of interest rate hikes by 0.5 percentage points after two major rate hikes. With the key interest rate level of 2.00 percent then reached, the Europeans still have a longer way to go than the Americans. At ten percent, inflation in the euro zone in November was still well above the US level of 7.1 percent most recently. In view of the particularly uncertain inflation outlook in the euro area, however, the experts are still very reluctant to make specific forecasts as to where the interest rate path will lead. However, many expect further rate hikes in February or March, possibly by as little as 0.25 percentage points.

The ECB balance sheet will only be reduced in the second quarter?

Another monetary policy instrument is less in the focus of public perception, but is highly explosive. At her meeting on Thursday, ECB President Christine Lagarde will give advice on reducing the trillion-dollar bond holdings that the central bank has accumulated since 2015 to support the economy and financial markets. While the Fed and BoE have already started scaling back this so-called quantitative easing – albeit at a snail’s pace – the ECB is also lagging behind.

However, according to the economists at AXA Investment Managers, it may still be April before the ECB actually begins to shrink its balance sheet, i.e. no longer replace expiring government bonds in its own portfolio with new ones. The bond markets in particular will be nervous about any move in this direction. After all, the most recent crises have led to massive new borrowing by the euro states, which has to be financed primarily through government bonds.