Keep hawkish and carry on (hiking)

FOMC Preview: 75bp hike and hints of more to come

The Fed is widely expected to raise the target range for the fed funds rate by 75bp this coming Wednesday, taking the range to 3.00-3.25%. While market expectations for a 100bp move initially received a boost following the strong August inflation print, those expectations have since been pared back, and as a result we think it is unlikely the Fed will opt for a 100bp hike at this meeting (the Committee has been in its blackout period in the meantime, with no guidance therefore on how the Fed interpreted the inflation data). Alongside the decision on rates, the Fed will also release updated FOMC projections for the economy and interest rates. Compared to the last update in June, we expect Committee members to lower their growth forecasts, raise inflation forecasts, and raise projections for the fed funds rate. Indeed, for the first time in this hiking cycle we think the Committee is likely to raise its projection for the fed funds rate to levels beyond our own forecast – 4% in the upper bound – likely to the c.4.5% range. The projections are also likely to suggest that monetary policy will remain restrictive through 2023 and into 2024, as the Fed seeks to assure markets and the public that it is determined to bring inflation durably back to its 2% target.

We still expect a Fed pivot in 2023, but don’t expect any communication shift soon

We are keeping our expectation for the peak in the fed funds rate upper bound at 4% by December, for the time being. While last week’s inflation print surprised markets, it was broadly in line with our expectation, and we continue to see signs of cooling in demand in many parts of the economy (for instance, retail sales last week suggested that real goods consumption is now broadly back at trend levels). Combined with falling commodity prices, the strong dollar, and easing global supply bottlenecks, we continue to expect inflation to fall substantially during the first half of 2023. This, alongside rising unemployment and a fall in the job vacancy ratio should give the Fed the confidence that it is on track to returning inflation back to target. However, the Fed will not want to signal any shift until we see convincing evidence of this in the data. As such, we expect the Fed to maintain its hawkish guidance to markets at least through to the end of the year.

BoE Preview: 50bp hike to accompany an upgraded growth outlook

The Bank of England’s Monetary Policy Committee is widely expected to hike its policy rate by 50bp this Thursday, taking Bank Rate to 2.25%. While expectations have built in the money markets for a bolder policy move (currently markets attach a 60% probability to a 75bp hike), the market has persistently over-estimated the size of BoE rate hikes over the past year, and we think the MPC will stick to a 50bp hiking pace for this meeting. With that said, the policy environment since the BoE’s last meeting in August has shifted dramatically following the appointment of new PM Liz Truss, and this is likely to mean a more hawkish Bank of England going forward. In particular, although the move to freeze household energy bills will mean significantly lower headline inflation than had previously been on the cards, it also stokes underlying inflationary pressure as it means the coming downturn in the economy is likely to be more shallow than previously thought. This means inflation could take longer to fall back to the BoE’s 2% target in the absence of a more aggressive rise in interest rates. As such, we are currently reviewing our expectation for the future path of Bank Rate (current projected peak: 3% in December), and will make a final judgment following the outcome of this Thursday’s BoE meeting, as well as the new Chancellor’s ‘mini budget’ due to be announced on Friday.