Macroeconomics: Hawkish Central Banks

• The major central banks are turning hawkish as headline inflation has surged to 8-9% in the US, UK and the Eurozone now.
• First, we expect the Fed to hike 50bps in June, July, September, and November and by 25bps from December onwards for fed funds to hit 3.00-3.25% this year and 3.75-4.00% in 2023.
• Second, the ECB is set to lift its -0.50% deposit rate by 25bps in July and signalled a 50bps move was likely in September now. We expect further 25bps hikes in October and December.
• Last, the BoE is likely to lift its 1.00% Bank Rate by 25bps at its next four meetings including this week to 2.00% before pausing in December.

The major central banks are turning hawkish as inflation keeps surging. Consumer price indices (CPI) are now rising by 8.6% in the US, 8.1% in the Eurozone and 9.0% in the UK. We thus expect more aggressive interest rate hikes in 2022.

First, the Federal Reserve is likely to raise its 0.75-1.00% fed funds rate by 50bps at this week’s meeting and by further 50bps hikes in July, September, and November before stepping back in December to 25bps rises. We therefore see the fed funds rate hitting 3.00-3.25% by year end and 3.75-4.00% in the first half of 2023

On Friday, May’s US CPI report was worse than feared. Inflationary pressures broadened due to strong reopening demand, firm wage growth, continued supply disruptions and record energy prices. Headline inflation jumped 1.0% MoM. This caused annual consumer prices to rise from 8.3% YoY to 8.6% YoY, a new four decade high. Excluding food and energy, core prices still rose 0.6% MoM. The chart above shows core inflation in annual terms dipped from 6.2% YoY to 5.9% YoY. But used cars prices surged 1.8% MoM, airfares 12.6% MoM and rents 0.6% MoM. The latter is significant as rents tend to be persistent sources of inflation. The chart shows owners’ equivalent rent (OER) is now increasing by 5.1% YoY.

The Fed thus faces sticky inflation far above its 2% target. It also faces higher inflation expectations. June’s University of Michigan survey showed 5-10Y expectations rose to 3.3%, a 14-year high.

Source: Bank of Singapore, Bloomberg.

With inflation expectations rising and unemployment at just 3.6%, we expect the Fed will need to increase its fed funds rate quickly to neutral levels around 2.50% this year and then into restrictive territory towards 4.00% in 2023 to slow the red-hot economy and lower inflation again. Therefore, we see the Fed sticking with 50bps hikes for its next four meetings and only stepping back to 25bps rises from December when the US economy starts to slow and unemployment rises.

More aggressive monetary tightening will increase the risks of the US suffering recession in 2023. But the risks seem greater in Europe given its dependence on imported energy, uncertainty over the war in Ukraine and fragmented Eurozone government bond markets. Last week, the European Central Bank committed to lifting its -0.50% deposit rate by 25bps in July and signalled a 50bps hike was likely in September to curb inflation. We see further 25bps rises in October and December to bring the ECB deposit rate up to 0.75% by year end. Similarly, we expect the Bank of England will now lift its 1.00% Bank Rate by 25bps at its next four meetings including this week to 2.00% before pausing in December.

This article was first published by Bank of Singapore on June 13, 2022. The Opinions expressed in this publication are those of the authors. They do not purport to reflect the opinions or views of Bank OCBC NISP Private Banking Tbk. or its affiliates.

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