The Central Bank’s Great Test of Strength By


By Geoffrey Smith — Central bankers may not want to see it that way, but this week’s round of policy meetings is coming down to a test of brute force.

What economy is strong enough to withstand the blows of huge interest rate hikes as the world’s monetary guardians try to tame the beast of inflation? It seems to be a short list.

Another surprise to the upside in US inflation in August has prompted speculation that the Federal Reserve will raise the federal funds target range by one percentage point on Wednesday, despite the headline rate falling to 8.3%.

A year ago, such an aggressive move, the biggest rate hike in nearly 30 years, would have been unthinkable. But inflation has been so acute and, increasingly, so broad that few would argue with the Fed if it hit 100 basis points.

In fact, most analysts now hold that the key issue of the meeting, and Chairman Jerome Powell’s subsequent press conference, will not be “75 or 100,” but rather what the infamous “dot plot” – which shows where Fed officials expect rates to go in the next two years – has to say about how high rates will have to go and how long they will have to stay there to bring down inflation.

Short-term dollar interest rate futures currently imply that the fed funds rate will peak at between 4.25% and 4.50% in April next year. This will require the Fed to hike a full 2 ​​percentage points in the next six months, meaning 100 basis points on Wednesday will have already done half the job. It follows that the rate of hardening will slow down considerably thereafter.

This “anticipation” pattern of rate hikes was already on display at the central bank’s first major meeting of the week on Tuesday, where Sweden’s Riksbank raised its policy rate by 100 basis points – more than expected – up to 1.75%.

However, the Riksbank’s own guidance on the future path of rates indicated that it only expects to rise another 75 basis points before starting to cut them in 2024, Gustav Helgesson, an economist at Nordea (ST:), said in a note to clients. .

“By raising the policy rate further now, the risk of high inflation in the long run is reduced and thus the need for further monetary policy tightening later on,” the Riksbank said in its statement.

It is true that the Riksbank – like many central banks in recent years – has been notoriously imprecise with its forecasts. But the argument for a sharp rise now to avoid further tightening later is likely to repeat itself throughout the week, especially on Thursday when the Bank of England holds its meeting.

It has suffered in recent weeks because the markets have lost faith in the Bank of England’s ability to match the Federal Reserve step by step, despite the fact that the United Kingdom’s inflation rate – above 10% and still rising in August – is considerably worse than that of the United States. Analysts expect the Bank of England to rise just 50 basis points, but the British economy is in such bad shape that any guidance on further rate hikes will be greeted with skepticism.

But by the time the Bank of England meets, the forex market may have bigger things to worry about. The – the latest and largest inflation-loose bank in the central banking community – will also meet on Thursday, at a time when the Japanese government is showing increasing signs of alarm over the yen’s depreciation. .

It is down 20% against the dollar in the last seven months alone, a decline that goes far beyond the benign depreciation that used to be embraced as support for exports.

Last week it was reported that the Bank of Japan was “testing rates” with currency traders, which is historically a prelude to intervention. But despite this, it seems that the Bank of Japan remains reluctant to relax its policy of reducing bond yields.

and they will also release their rate decisions on Thursday. But arguably the most interesting will be the emerging market meetings.

Brazil, which started its hike cycle early, is not expected to tighten its monetary policy any further. Neither is it expected to do so, which appears to have deliberately chosen the path of weakening its currency. But in and , rates will rise 75 and 100 basis points, respectively, moves that are likely to have a big impact on their respective economies.

BNP (EPA:) Paribas (OTC:) Chief Economist says global central banks are in the second phase of a three-stage tightening cycle. After an initial stage of panic about being “behind the curve”, they have moved into a stage of “perseverance” with rate hikes that they know will be painful, but necessary. After this, finally, comes “patience” as they wait for the policy tightening to take effect.

“Early tightening,” de Vijlder wrote in a note to clients this week, “should lead to a lasting reduction in the risk of inflation expectations spinning out of control.”

In the short term, “the aggressiveness of this approach raises concerns about a hard landing, but during this persistence phase, this does not prevent central banks from stepping on the brakes harder and harder.”

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