The hard decision facing central banks [Video]

Next week the Federal Reserve, Bank of England, and Swiss National Bank all meet. This time last week the SVB crisis was just dropping onto markets and since that time the decision for central banks has just got a lot harder. The fallout from the Credit Suisse crisis on Wednesday just underscored the difficulty for central banks. Do they hold back on hiking interest rates due to strains in the economy? Or do they keep hiking so inflation doesn’t get out of control?

Invariably in markets, someone always thinks a central bank has ‘got it wrong’. In an ideal world, with hindsight, all decisions can be made with 20/20 vision. It’s easy looking backwards to know what decision you should have made. However, in reality, it is usually more down to luck than skill when the timing is perfect in these decisions. That does not take away from the difficulty of their decision though and here are some of the factors influencing them.

The lag effect

Are the SVB crisis and Credit Suisse the first signs of economic activity being crushed? The answer is, ‘yes’. So, the next question is how many more banks will be affected. If the Fed hikes rates by 50bps next week will there be more banks under strain. Will investors start moving deposits from ‘riskier’ banks? The risk of contagion is real and when it happens, it happens very quickly.

The inflation fight

It’s not over. So, with the Fed backing up the SVB and the SNB supporting Credit Suisse will this type of ‘propping up’ keep global inflation pressures rising? If it doesn’t hike rates, will the core inflation rates around the world just keep rising? Core rates have been generally quite stubborn around the world. The US core was 5.5% for February.

The UK’s core inflation was 5.8% for January.

The Eurozone’s core inflation was 5.6% for February and is still trending higher.

So, the risk is that core inflation becomes entrenched if the central banks take their foot off the gas too quickly in terms of raising rates. However, what is ‘too fast’? The drop in the labour market numbers post-covid has kept wages firmer, so price pressures are still ‘in the system’.

The importance of next week

The pressures on central banks underscore the importance of next week and also the next moves for markets. After huge amounts of rate re-pricing over the last 7 days, one thing is for sure – expect volatility next week over the Fed’s meeting. Watch stocks and precious metals closely as some near-term trends could be set depending on how aggressive or otherwise central banks decide to be.

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