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25 Sept 2023 | 5 minutes to read
The US Federal Reserve’s Open Markets Committee (FOMC) voted last week to leave interest rates unchanged. The decision to keep the upper bound at 5.5% was widely anticipated but, the Committee surprised markets by delivering a more hawkish message than had been expected. Firstly, FOMC members’ forecasts of where rates will be, known as the “dot plot”, shifted higher. The dot plot now indicates one more hike in 2023, with rates ending 2024 at 5.125%, 2025 at 3.875% and 2026 at 2.875%. This represents a shift higher compared to the last set of forecasts, and suggests that rate cuts will happen only very slowly. The Fed’s GDP forecasts also improved, with no marked slowdown in growth now expected. The market reaction to the announcement was negative, reflecting the fact that monetary policy is likely to remain restrictive for longer than markets had priced in. This corresponded with declines in bond values, as well as a sell-off in richly valued equities, which have a greater sensitivity to bond valuations.
Like the Fed, the Bank of England (BoE) also voted to leave rates unchanged at the September meeting. However, markets had broadly expected the Bank to hike by 0.25%, especially following a strong wage growth print last week. The minutes indicated that the decision was very close, with four Monetary Policy Committee (MPC) members voting in favour of further hiking, and five voting against. The minutes also revealed that, while official Average Weekly Earnings data showed wage growth above 8%, other indicators suggested wage growth was not as strong, with many indicators pointing to the labour market easing. Further tightening is possible, but is unlikely if the economy evolves as expected, though higher oil prices and mixed messages from business surveys add uncertainty. While monetary policy was left unchanged, the committee did vote unanimously in favour of increasing the pace of “quantitative tightening” – QT. Bond sales will accelerate to £100bn in the next twelve months from £80bn in the prior twelve. Based on bank analysis, this pace is not expected to impact markets, leaving the pace of gilt reduction stable, given changes in the maturity profile of the BoE’s gilt portfolio.
Another factor that may have influenced the BoE’s decision was weaker-than-expected UK inflation data. The rise in oil prices was expected to push inflation higher in August but inflation actually declined dramatically from 6.8% to 6.7%. Core inflation declined even further, falling from 6.9% to 6.2%. Services inflation remains stable, while goods inflation accelerated, boosted by higher oil costs. However, this was more than offset by sharp falls in hotels and airfares. This could reflect weaker demand for travel, as households face a cost of living squeeze. However it could also reflect the change in the timing of data collection in July, which was closer than usual to school holidays, meaning recorded prices were higher in July and the month-on-month rise was lower in August. While inflation is expected to fall further this year and next, the path of inflation will be less easy to predict, with base effects becoming less of a driver and higher near term energy prices posing some upside risks to inflation.
The Bank of Japan (BoJ) also left monetary policy unchanged last week. The decision resulted in a sharp sell off for the Japanese yen against the US dollar, which likely reflected confusion as to the path of Japanese monetary policy, as well as the more hawkish than expected tone of the Federal Reserve. BoJ Governor Ueda commented “we have yet to foresee inflation stably and sustainably achieve our target and that is why we have to patiently maintain ultra-loose monetary policy.” However, this comes some weeks after Ueda hinted that monetary tightening could happen sooner than expected, with the Bank “now in a phase to gauge whether conditions would lead to wage growth next year.” These comments, coupled with the relaxation of the rules on the Yield Curve Control policy, had resulted in the yen strengthening.
Last week’s business surveys painted a gloomy picture. Purchasing Managers Indices (PMI), which reflect the sentiment of businesses, continued to signal weakness for the global manufacturing sector in September. What is more, the recent downturn in the Services sector in the UK and Europe seems set to continue, with readings in contractionary territory.
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