Executive briefing: Central Banks likely done with hiking rates

The past month has been characterized by tightening financial conditions, as still upbeat macro data and hawkish central bank commentary not least in the US have pushed back against the notion of early rate cuts. In line with our expectations, the ECB, Riksbank and Norges Bank hiked rates in their September meetings, which likely marked the end of their respective hiking cycles. Bank of England surprised by remaining on hold after lower-than-expected August inflation figures, while the Fed's pause was widely anticipated.

Most central banks continue to signal that the door for further hikes remains open if warranted by incoming data, but as we generally expect economic momentum and inflation to ease towards winter, we think policymakers will opt to remain on hold from here.

Leading economic indicators have remained at subdued levels, but we see no signs of an imminent recession either, consistent with our latest economic forecasts in Nordic Outlook - Divergent Fortunes, 5 September. Inflation data has generally come out on the lower side, with euro area September flash HICP showing welcome signs of easing core inflation. The Fed's preferred measure of underlying price pressures, the Core PCE, rose by only 0.1% in August in seasonally adjusted m/m terms.

Central banks face a more balanced risk outlook going forward. On one hand, resilient realized data, tight labour markets and recovering real income growth lift confidence in a soft landing scenario. On the other hand, rising yields, stronger USD, higher oil prices and weakening risk sentiment all contribute to further tightening in global financial conditions. As inflation and inflation expectations continue to moderate, the real monetary policy stance is becoming increasingly restrictive.

Especially rising oil prices amid seemingly weakening demand outlook have posed a conundrum for policy makers, as the evident upside risk for inflation could be offset by further decline in consumers' purchasing power. We see the uptick largely as supply-driven, and expect Brent prices to fall back to around USD85 per barrel by year-end.

While most central banks have likely reached the peak level for policy rates, yield curves have steepened driven by higher long-end bond yields. Besides expectation of rates staying high for longer, various estimates of term premium have inched higher. One factor potentially explaining the rising risks relates to the uncertain outlook for fiscal policy. Slower inflation, weaker real growth and higher interest rates push governments towards cutting spending to avoid rising debt-to-GDP ratios. On the other hand, the pressure for lose fiscal policy is strong in many counties. France and Italy recently lifted their estimates of next year's budget deficit, and US Treasury is set to increase issuance of longer-dated notes in Q4.

While China has showed up less frequently in news headlines, the challenges in the real estate sector have not faded. Unit of Evergrande, which kicked off the Chinese real estate crisis two years ago, missed a bond repayment in late September, sparking worries in the local markets. Leading data has pointed towards weakening consumption growth despite the central government's attempts to bolster confidence with new stimulus.

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