The upbeat sentiment that has fuelled equity markets of late dissipated this week amid renewed central bank hawkishness. Both the Bank of England and Norges Bank surprised markets with larger rate hikes than were expected, while the Swiss National Bank hiked by 25bps and signalled the prospect of more tightening ahead. These factors boosted the US dollar and led to more inverted yield curves.
BoE accelerates tightening
The BoE surprised markets with a larger rate hike than expected at this week's meeting. The Monetary Policy Committee (MPC) voted 7-2 to hike rates by 50bps to 5%, the pace of tightening accelerating from 25bps increases at the previous two meetings. As noted last week, renewed strength in wages growth meant a rate hike was assured, but it was a hot inflation report on the eve of the meeting that prompted the MPC to act more aggressively. Headline CPI inflation is in decline, though progress stalled in May printing at 8.7%yr (vs 8.4% exp); however, a rise in core inflation from 6.8% to 7.1%yr (vs 6.8% exp) marked a new high and clearly shocked the MPC.
External shocks, namely Covid and the war in Ukraine, initially led to a surge in UK inflation, but increasingly the drivers are turning to domestic factors with businesses raising prices to protect margins and households receiving higher wages for the cost of living. The MPC is concerned that the changing nature of inflation risks prolonging elevated price increases. Services inflation, which is the key focus for the MPC, pushed up from 6.9% to 7.4% to be running at its highest since the early 1990s. The MPC retained its guidance that developments consistent with persistent inflation pressures would see rates hike further. Markets anticipate the MPC will hike rates to a peak of 6% by year-end.
Fed remains on message...
Federal Reserve Chair Jerome Powell told Congress that further rate hikes in the US are expected to be needed, consistent with the messaging at last week's FOMC meeting. Despite inflation having decelerated significantly, Chair Powell said there was still "a long way to go" on the path back to the 2% target. Last week's decision to leave rates on hold was taken to allow the FOMC to take on board more data, acknowledging that the full effects on the economy from 500bps of tightening remain in the pipeline. That approach also meant that there was now less emphasis on the pace at which rates were being hiked than earlier in the tightening cycle.
... as does the ECB
Coming out of last week's meeting, the ECB reiterated its determination to do more to return inflation to target. In a speech, ECB Executive Board member Isabel Schnabel said that given the risk of high inflation remaining persistent, it was prudent for monetary policy to "err on the side of doing too much rather than too little". Schnabel identified three sources of upside risk to the inflation outlook including: i) ongoing supply shocks, ii) lasting effects on productivity from these supply shocks, and iii) a greater resilience in demand conditions than anticipated.
RBA adapting to inflation risks
More insights into the RBA's latest rate hike came to hand in the June meeting minutes. The emergence of upside risks to the RBA's inflation outlook has meant that its hiking pause in April was short-lived. As was the case in May, the Board considered leaving rates on hold but ultimately elected to hike, a judgment it again said was "finely balanced".
It was outlined that the risk of inflation staying higher for longer had increased. Specifically, the Board is wary that wage and price settings indexing to past inflation could become more widespread, while a more robust growth outlook, supported by rising housing prices in Australia and an improving global backdrop, could delay the process of returning inflation to the 2-3% target.
The Board's other mandate, full employment, was discussed in a speech by RBA Deputy Governor Michele Bullock this week. Bullock's main argument was that full employment goes hand in hand with inflation at the target. While the RBA expects the labour market to soften on the back of higher rates, it remains of the view that there is a path to achieving a soft landing.
