- Fed warns that it is too soon to tell how monetary policy should respond to banking fallout
- BoE says that inflation “remains likely to fall sharply over the rest of the year” despite recent surprise
The Bank of England and the US Federal Reserve both pressed ahead with quarter point interest rate hikes in the wake of financial market tensions triggered by the collapse of SVB.
The move takes UK interest rates to 4.25 per cent and raises the Federal Funds target to 4.75-5 per cent.
Policymakers faced a particularly tough balancing act this week as they weighed financial stability concerns against the need to tackle persistently high inflation. US inflation remains above target at 6 per cent, while the BoE’s decision was complicated by figures showing that UK inflation reaccelerated to 10.4 per cent last month.
On the one hand, hefty rate hikes this week risked exacerbating the stresses that triggered SVB’s collapse. But pausing could have carried its own hazards.
Eva Sun-Wai, fund manager at M&G Investments said that had the Fed left rates unchanged, it would have been “a huge signal to markets that financial stability meant more than the inflation-crushing narrative they've been thumping out for the good part of a year”. She added that a pause “would have signalled there were more worries bubbling under the surface in the banking sector”.
Success? Too soon to tell
Both the Fed and the BoE signalled that rates could be approaching their peak, but stressed that the full impact of this month’s banking turmoil remained uncertain.
The BoE said that it would make a full assessment of news “including the economic implications of recent financial market and banking sector developments” in the forecasts that will accompany the next meeting in May. The Bank judged that the UK banking system “remains resilient”, and is “well placed to continue supporting the economy in a wide range of economic scenarios, including in a period of higher interest rates”.
On Wednesday, Fed Chair Jerome Powell said that the fallout triggered by SVB’s collapse was “likely to result in tighter credit conditions for households and businesses”, but added that it was “too soon to tell how monetary policy should respond”.
The BoE maintained guidance that further tightening in monetary policy would be required “if there were to be evidence of more persistent [inflationary] pressures”. But this is not a done deal: in spite of last month's higher-than-expected inflation data, the Bank said that “CPI inflation was still expected to fall significantly in 2023 Q2”.
Some economists believe that today’s rate rise could mark the end of this tightening cycle. Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said that Thursday's increase would likely be the last. "While we can’t rule out one final 25bp hike, we think the [Monetary Policy Committee] likely will be reassured sufficiently by inflation developments over the next seven weeks to keep the Bank Rate on hold at its next meeting in May," he said.
Economists at Capital Economics said the BoE “may not yet be finished in its battle with inflation” and expect a May hike to take rates to 4.5 per cent, in line with market expectations.
Further US hikes “may be appropriate”
Though the Fed has previously signalled “ongoing increases” in rates, it struck a more dovish tone yesterday, saying only that further hikes “may be appropriate”. Projections released on Wednesday showed that the median forecast for interest rates in 2025 remained unchanged at 3.1 per cent. Nevertheless, the range of possible outcomes ranged from 2.375 to 5.625 per cent, suggesting a high degree of uncertainty.
Economists at ING said there could be a further 25-basis-point hike in May, but said that the resulting “higher borrowing costs and reduced access to credit mean a greater chance of a hard landing for the economy”. They said that rate cuts are likely to be “the key theme for the second half of 2023” as the economy struggles, and expect a 75-basis-point easing in the final quarter of the year as a result.
Following the BoE’s decision, the FTSE 100 was down 68 points or 0.9 per cent on the day. The pound edged higher against the dollar, gaining 0.5 per cent on the day at $1.2323. Yields on interest rate sensitive two-year gilts moved slightly, rising by 0.02 percentage points to 3.38 per cent.
US markets were initially buoyed on Wednesday by Powell's insitence that “all depositors' savings and the banking system are safe”. But the rally proved short-lived, and bank shares later slid after US Treasury secretary Janet Yellen ruled out a broad expansion of deposit insurance.
"With the rug effectively pulled out from under the teetering regional banks, stocks fell broadly, and credit spreads widened," said Daleep Singh, chief global economist at PGIM Fixed Income.
