Still Expensive Money
Four out of the top five influential banks have announced the preservation of maximum interest rates. These include the positions of the Federal Reserve, the European Central Bank, the Bank of England, and the National Bank of Switzerland. Although there are certain differences between America and Europe, the Bank of Japan signals that it may put an end to the prolonged period of negative rates and transition to positive ones by the end of January. This means that money will remain expensive in the coming months. However, if inflation continues to decline, a shift towards cheaper money in 2024 is probable. As financiers often say in such cases, if you haven't taken an expensive loan yet, don't rush; it will become more affordable. Meanwhile, as a result of signals from leading central banks, the rates of stocks, cryptocurrencies, gold, and key European currencies have risen.
For two consecutive days, Federal Reserve leaders deliberated before announcing the expected decision to maintain their rates and a draft on their reduction in 2024. The anticipated decision, already factored in by all markets, was declared on December 13. The next day, the European Central Bank and the Bank of England announced the preservation of their rates. Why did they do so? Because the rates are already raised to the highest levels, and inflation is gradually decreasing.
Currently, central banks are trying to consolidate the achieved results. Traders and investors behave as if the decision to reduce rates by central banks in the first or second quarter of 2024 has already been made and preliminarily announced. Although things may still change, heads of central banks suggest, for whom interest rates are the most potent financial weapon. Taking the example of the Federal Reserve System, it consistently increased its rate for 12 months until August of this year, reaching 5.33% per annum. However, the four recent decisions of the Federal Reserve did not change this rate, including the December decision.
The rally in interest rates actually began in July 2022, although the annual inflation rate in the USA peaked at 9.1% in June 2022. It was a 40-year high for dollar inflation. In the Eurozone, the maximum inflation of 10.6% was recorded in October 2022. The British pound sterling had its maximum inflation in October at 11.1% per annum.
Subsequently, the Federal Reserve, ECB, and the Bank of England competed to see who could hit inflation harder with their interest rates, until the autumn of 2023. Now they are competing to see who will dare to start reducing rates later.
Federal Reserve Pencils In
The most important news is that the Federal Reserve System has maintained its key interest rate unchanged for the third time in a row but unveiled a draft of its schedule for reducing this rate in 2024 and beyond.
This decision is based on the reduction of the inflation rate and the strengthening of the economy. Representatives of the Federal Open Market Committee, who unanimously voted for these decisions, are pleased that against the backdrop of declining inflation, economic recovery continues. This allowed them to maintain the overnight lending rate in the target range between 5.25% and 5.5%.
And the tentative schedule of rate cuts foresees three cuts by a quarter of a percentage point each in 2024. This is not too aggressive, significantly slower than the pace of increases in 2022, but it has already impressed traders and investors. Stock indices, stocks, cryptocurrencies, and precious metals have risen actively throughout the past week. For example, the Dow Jones Industrial Average jumped more than 400 points, surpassing 37,000 for the first time.
The announced pace of rate cuts by the Federal Reserve is less than the market expected but more powerful than previously stated by Federal Reserve officials. It aims to reach 4.5-4.75% by the end of 2024. Over the longer term, four cuts are expected in 2025 and three in 2026. This should bring the Federal Reserve rates to the range of 3.5-3.75% at the end of 2025 and to 2%-2.25% at the end of 2026. The latest figures are already close to the long-term forecast for rates. That is, we will see a significant softing of money from the Federal Reserve, but not as ultimately powerful as the markets would prefer, enjoying the period of 2021-2022 with extremely cheap money.
"Inflation has subsided from its peaks, and this happened without a significant increase in unemployment. This is very good news," said Chairman Jerome Powell during the press conference on December 13. "Recent indicators suggest that the growth of economic activity has significantly slowed compared to the excessive pace observed in the third quarter. Nevertheless, GDP is expected to increase by approximately 2.5% annually overall." If this is not a signal for rate cuts since February-March, then what is it? Federal Reserve officials hope that the gradual reduction in inflation will lead to its return to the target level of 2% by 2026.
PHOTO: European Central Bank President Christine Lagarde says "we haven't even discussed it." The ECB currently has no plans to reduce its rates. SOURCE: Getty Images
Europe Proceeds with Caution
The Governing Council of the European Central Bank (ECB) announced on December 14 its decision to keep the current key interest rates unchanged. In particular, the rate for main refinancing operations has been maintained at 4.50%. This decision marks the second consecutive meeting where rates remain unchanged. It likely signals the end of the rate hike cycle initiated 17 months ago.
However, there is a crucial caveat in the ECB's statement: "While inflation has been easing recently, a temporary increase is expected in the near future." This is unlikely to signify a return to rate hikes, but rather suggests that the ECB hasn't formulated specific plans for rate cuts. Such intentions are based on inflation forecasts. According to these forecasts, overall inflation is expected to average 5.4% in 2023, decrease to 2.7% in 2024, further decline to 2.1% in 2025, and ultimately stabilize at 1.9% in 2026. In other words, the inflation target will only be achieved in three years.
In a brief summary, the situation appears as follows: ECB President Christine Lagarde does not see the need to announce rate cuts here and now, unlike her counterparts at the Federal Reserve. She debunked potential expectations of a rate cut, stating, "We absolutely do not need to lower our guard... We have not discussed lowering rates at all." This has already led to the euro rising against the dollar, reaching approximately 1.10, and has somewhat subdued the European stock market.
The Bank of England also maintained its rates on December 14. Of the nine members of the Monetary Policy Committee (MPC) of the Bank of England, six votes were in favour of keeping the bank rate at 5.25%. However, three committee members preferred to raise the bank rate by 0.25 percentage points to 5.5%. This is an almost aggressive policy to achieve the 2% inflation target while still supporting economic growth and employment. The pound sterling immediately rose to 1.28 against the dollar, up from 1.26 earlier in the day before. Frankly, the markets had anticipated this earlier, as the rise began at the end of October, from levels of 1.21 dollars per pound sterling.
In essence, two key European central banks have extended the timeout in raising interest rates and discarded announcements of their reduction. This has already led to an increase in European currencies against the dollar. Further increases in the euro and pound are not ruled out if the ECB and the Bank of England maintain their rates against the backdrop of the Federal Reserve's fairly active rate cuts.
PHOTO: Andrew Bailey, Governor of the Bank of England, is not rushing with a reduction in the policy rate along with colleagues. SOURCE: Getty Images
Swiss National Bank Maintains Rates
On December 14, 2023, the Swiss National Bank (SNB) announced its decision to keep the interest rate at 1.75% annually. The previous review took place in June, approximately six months ago. At that time, the central bank, for the fifth consecutive occasion, raised the key interest rate to its current level.
The series of rate hikes began in June 2022 when the Swiss National Bank increased its policy rate to -0.25% from the previous -0.75%, which had been in place since 2015. This move led to a sharp appreciation of the Swiss Franc against other major currencies.
Subsequent increases occurred in September (+0.75 percentage points) and December 2022 (+0.5 percentage points), as well as in March (+0.5 percentage points) and June (+0.25 percentage points) 2023. The rate hike in June already showed a slowing pace. The SNB reviews the key rate at the end of each quarter, and the September 2023 review saw no changes in the rate. The next review is scheduled for March 2024, and it appears likely to happen without alterations, at least as the current situation suggests.
The basis for such an assumption lies in the somewhat reduced inflationary pressure over the last quarter. The SNB's communication stated this conclusion about inflation and was disseminated in connection with the decision to keep the policy rate unchanged.
In its statement, the Swiss National Bank referred to the ongoing uncertainty, emphasizing its commitment to closely monitor developments and adjust monetary policy "if necessary." The aim of such a policy is to ensure price stability in the medium term. In essence, it showed no intention of tightening monetary policy, unlike several previous communications. However, the Swiss National Bank announced its readiness to intervene in the currency market to mitigate exchange rate fluctuations if necessary.
Indeed, there are objective reasons for such a position, as inflation in Switzerland has slightly decreased since the last rate review in September and now firmly stays within the SNB's target range of 0 to 2%, specifically at an annual rate of 1.4%.
In reality, Switzerland has the lowest interest rate among countries that host key reserve currencies, excluding Japan, where the rate stands at a negative 0.1% annually and has remained unchanged, even in the face of overcoming the consequences of COVID-19. However, the Bank of Japan is highly likely to review its rate in January 2024, moving it towards an increase, thereby ending its multi-year presence in negative territory.
Returning to the Swiss Franc rate, which, due to the rally initiated in June 2022, has been steadily strengthening. Over the course of one and a half years, the increase has been around 5% against the Euro, reaching the current €1.05 per Franc. It's not groundbreaking news, as every financial crisis has led to the strengthening of the Franc before. The four years of overcoming the debt crisis from 2008 to 2012 ultimately resulted in a one-third increase in the Franc, reaching €0.82.