Obvious message by major central banks: Tightening to stay for longer

Berenberg Bank on Friday adjusted its terminal rate forecasts in light of the developments of the last 48 hours, adding an additional 25 basis point rate hike for the Fed in 2023, taking the peak to a range between 5% and 5.25% over the course of the first three meetings of the year.

Fed Chair Jerome Powell signaled that despite recent indications that inflation may have touched its peak, the battle to get it back under control is still far from over. One day after Fed’s policy decision, on Thursday, the ECB was the next to decide a smaller interest rate hike but suggesting it would need to raise rates “significantly” further to tame inflation.

Fed, ECB, BoE and Swiss National Bank all raised interest rates by 50 basis points within the same week, in line with expectations. Markets exhibited negative reactions after the Fed’s decision on Wednesday’s hiking benchmark rate by 50 basis points to its highest level in 15 years. This marked a slowdown from the previous four meetings, at which the central bank implemented 75 basis point hikes.

“There is an expectation really that the services inflation will not move down so quickly, so markets will have to stay at it,” Powell said in Wednesday’s press conference, adding that “We may have to raise rates higher to get where we want to go.”

Berenberg bank also upped projections for the ECB, which it now sees raising rates to “restrictive levels” at a steady pace for more than one meeting to come. Berenberg added a further 50 basis point move on March 16 to its existing anticipation of 50 basis points on Feb. 2. This takes the ECB’s main refinancing rate to 3.5%.

The Bank of England also implemented a half-point hike, adding that it would “respond forcefully” if inflationary pressures begin to look more persistent. The major central banks had given the markets a clear message that financial conditions need to remain tight for longer.

The whole of 2022 has been about rising real rates. Now that central banks have achieved this, the 2023’s key topic is expected to be different; namely preventing the market from doing the opposite. This is why buying risky assets under weak inflation circumstances is in contradiction with the goal of suppressing and weakening inflation.

The ECB and the Fed’s explicit shift in focus from the consumer price index (CPI) to the labour market is notable, as it implies that supply-side movements in goods are not sufficient to declare “mission completed”.

The hawkish messaging from the Fed and the ECB surprised the market somewhat, even though the policy decisions themselves were in line with expectations. Economists think that a decline in inflation to c3% and a rise in unemployment to above 4.5% by the end of 2023 will eventually trigger a slower pace as well as less tightening, but now, the Fed clearly intends to go higher for longer to protect and support the US dollar as a natural result that will be felt across financial markets.