Global markets continue to behave reasonably well as measures of equity volatility sit near multi-year lows. This is encouraging given some new uncertainty around interest rates. The U.S. Federal Reserve, Bank of Canada, and European Central Bank all provided policy updates over the past few weeks. While there were some differences as one would expect, there was one consistent message: inflation remains an issue and they aren’t quite done with rate hikes.
The Fed decided to keep interest rates on hold for the first time since early 2022 (previously, it had hiked rates at ten consecutive meetings). This action had been well telegraphed and came as no surprise to the market. Nevertheless, comments and projections made by the committee caused a bit of a stir as investors were left to digest some new information. First, Chairman Jerome Powell tried to indicate the pause was aimed at slowing the speed at which interest rates have been rising over the past year, rather than officially marking an end to their rate tightening campaign. Those comments were supported by the Fed’s updated projections which suggest the committee still expects to raise interest rates by as much as half a percent through the rest of the year. Moreover, the Fed raised its estimates for economic growth and inflation and lowered its forecast for unemployment this year as it acknowledged the resilience of the U.S. economy in the face of much tighter financial conditions. They did lower their forecasts for 2024, believing challenges will eventually arise as rate hikes take their toll.
Meanwhile, the Bank of Canada, which was one of the first central banks to begin its rate tightening campaign in 2022, and one of the first to pause earlier in 2023, resumed its rate increases just over a week ago. More interesting were comments made in the official statement which suggested they have concerns inflation could get stuck materially above their target, and that policy may still not be restrictive enough to cool demand. This clearly leaves the door open to more interest rate increases in the months to come.
Most recently, the European Central Bank continued with its rate hiking campaign by increasing rates for the eighth consecutive time. In some ways, the ECB is playing catch up as it was slower to initially raise interest rates last year. The region continues to see various measures of price pressures that are higher than what are being witnessed in North America. As a result, the ECB was clear with its intentions going forward, saying that “we are not thinking about pausing”. It remains committed to getting inflation back closer to target but acknowledged it will take time as it doesn’t expect that to happen until 2025.
These recent updates highlight the quandary that faces central banks. On the one hand, the resilience of the economies can be construed positively as it suggests consumers and businesses have adapted reasonably well to higher interest rates. But on the other hand, the strength may mean underlying inflationary forces continue to percolate. The longer these pressures persist, the greater the risk they become entrenched in longer-term inflation expectations. As a result, we expect central banks to continue to prioritize getting inflation under control. We are hopeful this can happen without too much more intervention in the form of rate hikes but remain mindful that further increases raise the odds of an economic capitulation at some point in the future.