It’s been a busy start to the month for central bank watchers with the Federal Reserve (Fed), the Bank of England (BoE), and the European Central Bank (ECB) announcing their policy decisions in quick succession. The Fed raised its policy rate by 25bps to 4.75% and the BoE and the ECB^[1] by 50bps each, taking their policy rates to 4% and 2.5%, respectively. This was in line with market expectations. Yet bonds and equities have rallied, and markets have been pairing back expectations of rate hikes and are pricing in larger rate cuts.

The Federal Reserve

Fed Chair Jerome Powell struck a relatively dovish tone in the press conference following the monetary policy decision. The Federal Open Market Committee (FOMC) did not change its policy guidance or its assessment that job gains have been robust and the unemployment rate low. However, it adopted a more balanced view on inflation, noting that inflation has eased, although it remains elevated. Powell took comfort from goods deflation, but noted that core services inflation has barely slowed. More importantly, he did not push back against market pricing of rate cuts this year and was not perturbed by easier financial conditions.

The Bank of England

Separately, the BoE refrained from committing to further rate hikes, let alone raising the policy rate ‘forcefully’ despite wage growth being persistently stronger than its expectations. Governor Bailey said that the economy is turning a corner although risks still loom large. Monetary Policy Committee (MPC) members noted that further rate hikes will come if wage growth and services inflation overshoot the BoE’s central case. The Bank also published its new Monetary Policy Report which saw upward revisions to growth and downward revisions to inflation, as expected. The economy will still be in a recession during 2023-24, although the recession will be shallower than expected. Crucially, despite downward revisions to inflation forecasts, inflation is likely to be more persistent. The potential supply of the economy is lower and this could keep underlying inflation elevated for longer.

The European Central Bank

The ECB had the most hawkish tone of the three central banks. It ‘intends’ to raise the policy rate(s) by 50bps again in March and it will then re-evaluate the subsequent path of monetary policy. ECB President, Christine Lagarde, noted that strong underlying inflation, wage growth and wage negotiations, and a large fiscal policy response warrant a 50bps increase in March. Whilst emphasising policy continuity and consistency, she said that the ECB has not reached the peak rate and that they have ground to cover. The central bank no longer sees risks to growth tilted to the downside or risks to inflation skewed to the upside – both risks are more balanced now.

What does this all mean?

Whilst the narrative for last year was inflation persistence, this year’s narrative is turning out to be swifter disinflation even as growth slows less than previously expected. If headline and core inflation fall faster than previously expected due to goods deflation, lower oil and gas prices, and easing supply chains, the extent of the decline and the sustainability of the disinflationary trend depends on the labour market and ‘core’ services inflation. The jury is still out on the extent to which labour market imbalances have been resolved and this will be key in determining whether market exuberance is justified.

[1] ECB deposit rate