David McNamara: Central banks are not finished in the rate-hiking cycle

The market is attaching a high probability to a 25bps rate hike in December.

The latest set of central bank meetings saw all the kick to touch, with further hikes expected before year-end. 

The US Federal Reserve, as expected, left its interest rate policy unchanged. The target range for the Fed funds rate was maintained at 3.75-4.00%. The decision to leave rates unaltered was not unanimous, with the two dissenters in favour of a 25bps rate hike. The meeting statement contained no significant changes compared to its September edition. It did, however, upgrade its characterisation of the pace of growth in activity from “solid” to “strong”. 

In the post-meeting press conference, Chair Kevin Warsh continued to emphasise the inflation aspect of the Fed’s dual mandate, noting that it is the central bank’s “responsibility to get inflation down”. However, in a similar vein to the meeting statement, he commented that the “period in front of us is information rich”. In other words, the next meeting in December is very much a ‘live’ meeting.

The October meeting of the ECB’s Governing Council also saw the central bank leave its key interest rates unchanged. The deposit and refi rates were maintained at 2.50% and 2.65%, respectively. The meeting statement, once again, stated that the ECB view the “risks to the inflation outlook are to the upside”. 

At the post-meeting press conference, there were several questions in relation to the announcement that President Lagarde would be stepping down early from her position, distracting somewhat from monetary policy issues. However, Lagarde did give strong indications that December was a ‘live’ meeting in the context of further rate hikes. Meanwhile, on questions in relation to France and its current elevated yields, Lagarde noted that while the ECB has instruments available, the main solution lies with French domestic fiscal policy. 

The market is attaching a high probability to a 25bps rate hike in December, which seems a sensible assessment. The market also envisages rates rising by a further 50bps in 2027. However, rates may settle a little lower than markets expect. The recent tightening in financial conditions, as well as limited second-round inflationary effects so far, may limit the extent of additional rate increases the ECB needs to implement.

The UK economy has also seen a rapid tightening in financial conditions, but on the fiscal policy front, the UK Chancellor announced last week a relatively ‘boring’ budget compared to some of the blockbuster packages of recent years. The overall reaction to Chancellor Healey’s speech was muted within both the UK press and, more importantly, the bond market. The budget detailed a myriad of micro-measures adding up to a small giveaway in the next couple of years, followed by a takeaway in later years. The big picture is the UK government has little room for manoeuvre, with debt interest spending set to rise sharply and other spending pressures mounting. The new government is also keeping its powder dry ahead of publishing a 10-year plan later this year, and its crucial spending review in the Spring of 2027.

David McNamara is chief economist at AIB