Banks central to diverging monetary policy theme on display

Summary

A key theme across currency and fixed income markets over the last few years has been diverging paths for monetary policy between central banks around the world. This monetary policy divergence theme was on full display this week. Many G10 central banks met over the course of the week, and while nuanced differences were communicated, policymakers are not necessarily acting in unison. In the emerging markets, local institutions are drifting further from G10 central banks, but also intra-EM divergences have become more observable just this week. In this report, we recap this week's central bank decisions and offer views on the monetary policy outlook for certain institutions going forward.

G10 central banks: Nuanced divergences

While there are significant divergences between the approaches of the G10 and emerging central banks, this week's heavy schedule of announcements showed a much more nuanced contrast within the G10 central bank space. Some central banks opted to hike rates further and many held policy interest rates steady, while central banks also delivered differing messages in their accompanying statements.

The most significant of the major central bank policy announcements was that of the Federal Reserve, which held the target for its fed funds rate steady at 5.25%-5.50%. However, in the context of slower but still strong job growth, a low unemployment rate, and elevated inflation, the Fed left the door open for further tightening, and also signaled interest rates could remain higher for longer. Specifically, the “dot plot” projections showed a median fed funds forecast of 5.625% for the end of 2023, which would be consistent with one more 25 bps rate hike. In addition, policymakers saw rates falling only slightly to 5.125% by the end of 2024. While we think a mild U.S. recession and slowing inflation will see the Fed lower its policy rate to a range of 3.00%-3.25% by the end of next year, to the extent the U.S. economy remains resilient, the risks appear to be tilted toward later and/or more gradual rate reductions.

Another central bank to pause this week was the Bank of England (BoE). In a finely balanced decision, BoE policymakers voted 5-4 to hold their policy interest rate at 5.25%. While holding interest rates steady, the BoE in a key change noted mixed developments on indicators of inflation's persistence. The central bank said the recent acceleration of average weekly earnings is not consistent or apparent in other wage measures, while also noting downside news on services inflation, which slowed to 6.8% year-over-year in August. The central bank also cited soft GDP growth and rising unemployment. While the BoE did leave the door open to further tightening it appears this interest rate pause could also be a peak, with the BoE describing monetary policy as restrictive and adding that “monetary policy will need to be sufficiently restrictive for sufficiently long to return inflation to the 2% target”. We expect the BoE's policy rate to remain at 5.25% for an extended period, and do not forecast an initial modest 25 bps rate cut until May 2024.

The Swiss National Bank (SNB) also stayed on the sidelines this week as its held its policy rate at 1.75%, in contrast to the consensus forecast for a 25 bps rate hike. Notably, the SNB lowered its medium-term inflation forecast. After forecasting 2.2% inflation for both 2023 and 2024, the SNB projects inflation of 1.9% in 2025, just within the range of price stability. The SNB also said it expects economic growth to be very weak for the rest of this year. As a result and even though the SNB said further monetary tightening cannot be ruled out, we believe that SNB rate hikes are probably done. We also forecast the RIksbank, Sweden's central bank, has reached the end of its monetary tightening cycle. The Riksbank raised its policy rate 25 bps to 4.00%, saying that inflationary pressures within the Swedish economy were still too high even as previous rate increases and falling energy prices have started to contribute to slower inflation. The Riksbank said that rates could still be raised further, although that outlook was not fully supported by its economic projections which saw CPIF inflation returning to 1.8% by 2025, and a peak in the policy rate path of 4.10%, suggesting a less than even chance of further monetary tightening.

One central bank that still appears likely to raise rates further is Norges Bank, Norway's central bank. The Norges Bank raised its policy rate 25 bps this week to 4.25%, and said there would likely be one more policy rate hike, most probably in December. Underlying CPI inflation remains elevated at 6.3% year-over-year in August, while wage growth is projected at 5.5% for 2023. And while the central bank's mainland GDP growth forecasts of 1.3% for 2023 and 0.3% for 2024 are not especially strong, they are little changed from previous projections. Against this backdrop, Norway's policy rate is expected to remain at elevated levels for an extended period—indeed, the Norges Bank projects the policy rate will lie around 4.5% through all of 2024.

Finally, another central bank that might raise its policy interest rates in the future is the Bank of Japan (BoJ), though it is unlikely to do so for many months or quarters. This week's Bank of Japan monetary policy announcement was very benign. The BoJ kept its policy rate at -0.10% and made no change to its 10-year JGB yield target, while also saying it would add to monetary easing if needed and that inflation was likely to decelerate moving forward. In the only reference to a possible policy shift, BoJ Govenor Ueda said that if the inflation goal comes into sight, authorities would mull whether they need to lift interest rates or end the Yield Curve Control program. Based on recent economic trends and central bank comments, we believe the Bank of Japan is unlikely to contemplate a policy adjustment until next year at the earliest.

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