The volatility of equity prices in global markets has recently been near multi-year lows, despite renewed uncertainty regarding the path of interest rates. The U.S. Federal Reserve, Bank of Canada and European Central Bank provided policy updates over the past few weeks. While there were some differences among their guidance, there was one consistent message: inflation remains an issue, and central banks are likely not finished with rate hikes.
This month, the U.S. Federal Reserve decided to keep interest rates on hold for the first time since early 2022 (it had previously hiked rates at ten consecutive meetings). This action had been well-telegraphed by the Fed and came as no surprise to the market. Nevertheless, comments and projections made by the Committee contained new information. First, Chairman Jerome Powell stated that 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 the Fed’s tightening campaign. Those comments were supported by the Fed’s updated projections, which suggest that the Committee still expects to raise interest rates by as much as 0.50% through the balance of this year. The Fed raised its estimates for economic growth and inflation and lowered its forecast for unemployment this year. It pointed to the resilience of the U.S. economy in the face of much tighter financial conditions. The Fed did lower its forecasts for 2024, stating that economic challenges will eventually arise as rate hikes take their toll.
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 on June 7th. The comments made in the Bank’s official statement included concerns that inflation could get stuck materially above the Bank’s long-term target of 2%, and that the current policy interest rate may still not be restrictive enough to cool demand. This comment left the door open to more interest rate increases in the months to come.
On June 21st, the European Central Bank increased its policy rate for the eighth consecutive time. In some ways, the ECB is playing catch up, as it was slower to initiate interest rate increases last year. Europe 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, stating that “we are not thinking about pausing”. It remains committed to getting inflation back close to its long-term target but acknowledged that the target may not be reached until 2025.
These recent updates highlight the quandary facing central banks. On one hand, the resilience of global economies can be construed positively, as it suggests that consumers and businesses have adapted reasonably well to higher interest rates. On the other hand, the strength may mean that underlying inflationary forces continue to percolate. The longer that inflationary pressures persist, the greater the risk that they become entrenched in longer-term inflation expectations. As a result, we expect central banks to continue to prioritize bringing inflation under control. We are hopeful this can be achieved with modest additional intervention in the form of further rate hikes. The further rate increases raise the probability of a recession occurring this year or early next year.
If you have any questions, please do not hesitate to contact us.
Drew M. Pallett LL.B. CFP
Senior Portfolio Manager and Investment Advisor
RBC Dominion Securities
Email: drew.pallett@rbc.com
Website: www.pallett.ca