Investors prepare for slowing global interest rate rises

Three of the world’s biggest central banks are expected to raise interest rates this week, but investors wary of economic recessions are turning their attention to where borrowing costs might peak in 2023.

Investors expect the Federal Reserve, the Bank of England and the European Central Bank will increase interest rates at meetings this week but at a slower pace than in recent months.

Central banks on either side of the Atlantic have rapidly raised borrowing costs from historic lows this year in an attempt to cool racing inflation that has been exacerbated by Russia’s botched invasion of Ukraine.

Interest rates have risen from close to zero to between 3.75 per cent and 4 per cent in the US, 1.5 per cent in the eurozone and to 3 per cent in the UK, hammering global financial markets in the process.

However, investors have been encouraged by signs of easing inflation in the US and the eurozone in recent weeks and are shifting their focus from the size of policy moves to the level at which rates will eventually plateau next year.

Fed chair Jay Powell “has all but promised” a smaller 0.5 percentage point increase on Wednesday, said David Donabedian, chief investment officer at CIBC Private Wealth, with markets likely to hone in on the central bank’s forecasts for interest rates next year.

Markets are pricing in that the Fed’s main policy rate crests around 5 per cent next spring before falling in the second half of the year, though Powell is expected to stress that the central bank’s fight against inflation is far from won. “The Fed will never admit this, but their behaviour suggests that they don’t really want to give the stock market a lot of good news,” Donabedian said.

“From their perspective, [the message] is working,” he added. “Inflation numbers have started to come down, there are signs of weakening in key sectors of the economy, and the stock market is more or less flat versus where it was six months ago.”

Hotter than expected US consumer prices for November could yet prompt a big sell-off in equities, though economists expect inflationary pressures to continue to ease.

The ECB is also expected to raise rates by 0.5 percentage points, though Europe’s reliance on expensive natural gas means “it’s a completely different situation there compared with the US,” said Didier Rabattu, head of equities at Lombard Odier Investment Management.

Inflation in the eurozone fell for the first time in 17 months in November, dipping to 10 per cent from 10.6 per cent in October thanks to a slowdown in energy and services prices. Even so, the ECB has “no credibility left in fighting inflation, because it simply can’t,” Rabattu said.

The central bank is at once powerless to influence energy prices and wary of devastating the housing and jobs markets with higher rates, he added. “The ECB doesn’t want riots on the streets.”

Investors are meanwhile betting that the Bank of England’s Monetary Policy Committee will opt to raise rates by 0.5 percentage points rather than repeat last month’s 0.75 percentage-point move. The UK has the worst growth outlook of any big economy, house prices are falling at the fastest rate since the 2008 financial crisis and millions of public sector workers are threatening to strike over pay.

“Unlike in the euro area, we view the risk of inflation getting embedded in the UK as much higher,” said analysts at Bank of America, who think the BoE will raise rates to 4.5 per cent by May next year even as the economy tips into recession.

At 8 per cent, wage growth “remains far too high,” the bank said, suggesting “very strong domestic [consumer price inflation] running well into 2024.”

Additional reporting by Nicholas Megaw in New York