The latest round of central bank meetings in the US, UK and the euro zone all point to an end to interest rate rises. These central banks face similar conditions; inflation is moderating but is still some distance from their official targets. They should start to pay more attention to recession risks in the quarters ahead.
Economic growth momentum is slowing, especially in the manufacturing sector. The manufacturing purchasing manager indices (PMI) for the US, UK and euro zone are all below 50. This suggests the sector is facing contraction pressure. The service sector PMIs are also weak. Unsurprisingly, the high interest rate environment is starting to cool economies.
Given this backdrop, these three central banks are strongly indicating that the rate hike cycle is coming to an end. The futures market echoes this view. It is pricing in only a 20 per cent and 45 per cent chance of a 25-basis-point hike by the European Central Bank (ECB) and the Federal Reserve respectively by the end of the year.
The ECB raised its policy rate on September 14 by 25 basis points, to 4 per cent. It did hint that this could be the end of the cycle, as rates have reached a level that would contribute to bringing inflation back towards its 2 per cent target. The Bank of England surprised the market by leaves rates unchanged, partly due to the unexpectedly soft inflation data in August.
Investors are now looking beyond the hikes to anticipate when rate cuts could come. They could be disappointed, though, as the end of the hiking cycle does not imply rate cuts could come any time soon.
The Fed’s latest “dot plot” of policy rate forecasts shows that 10 out of 19 Fed officials still expect the rate to be above 5 per cent by the end of 2024. Comments from Fed chair Jerome Powell and other senior officials suggest the central bank’s priority remains cooling inflation. The “higher for longer” stance could prevail in the months ahead.
The belief that the economy can withstand high rates could be soon challenged. As mentioned, the UK and European economies are already facing growth headwinds, as higher borrowing costs weaken corporate investment and increase interest payments for mortgage borrowers.
In the US, the housing market and corporate spending are already slowing. Yet, the strong job market and robust consumption are keeping the economy on a steady growth path. That said, the Fed needs to be mindful of the potential pitfalls ahead.
At the time of writing, the United Auto Workers strikes are still ongoing. Prolonged industrial action would affect the auto industry and associated supply chains. And the US government was heading for a shutdown on October 1, if both chambers of Congress fail to pass a spending plan. Historically, these shutdowns have lasted from a day to several weeks. The federal government shutdown in late 2018 went on for 34 days.
It is difficult to precisely quantify the impact of these shutdowns, but hundreds of thousands of federal workers won’t be paid or would be furloughed during a shutdown. The impending shutdown comes when inflation is still a top economic problem for households. For example, the recent rise in oil prices has seen petrol prices in the US hit their highest level in a year.
Neither a government shutdown nor union strikes would be enough to tip the US economy into a recession on their own. However, consumer and business sentiment could weaken further into the new year. As we approach the US presidential election in November 2024, political posturing could disrupt government operations and economic activities.
The Fed’s assessment of the economy at this point is consistent with recent solid economic performance. However, as the experience of the UK and Europe shows, high interest rates will eventually put pressure on the economy while central banks will also need to factor in other risks.
Central bankers do need to re-establish their inflation fighting credibility, but overcorrecting a past policy error could lead to a fresh mistake, and bring economic hardship ahead of a critical election year.
Tai Hui is chief market strategist for the Asia-Pacific at JP Morgan Asset Management