Interest rate paths for US, Europe set to differ | Popgen Tech


FRANKFURT—The Federal Reserve’s aggressive campaign against high inflation has dominated global financial markets this year. Starting this week, the action shifts to Europe, where inflation may be tougher and harder to tame. That shift is likely to reverse some of the key market dynamics of 2022, most notably a super-strong dollar.

At monetary policy meetings this week, the Federal Reserve’s key rate is expected to rise by 0.5 percentage point, the European Central Bank’s by 0.5 to 0.75 point, and the Bank of England’s by 0.5 point.

Over the next year, however, their paths will likely diverge. Investors expect the Fed to raise rates by just 0.6 percentage point through December 2023, compared with 1.25 percentage points for the ECB and 1.5 points for the Bank of England, according to market data from Refinitiv.

Federal Reserve Chairman Jerome Powell said at a Brookings Institution event that the central bank is prepared to slow the pace of rate hikes as soon as its December meeting. Photo: Valerie Plesch/Bloomberg News

A divergence between the world’s major central banks is likely to ripple through global financial markets, boosting the euro and pound sterling against the dollar, while lowering European government bond prices relative to US Treasuries. Bond prices fall as yields rise.

Inflation is starting to fall in both regions, but more so in the US, where it tumbled by 1.5 percentage points since June to 7.7% in October. In the eurozone, inflation eased to 10% in November from a record high of 10.6% in October. In the UK, inflation rose to 11.1% in October, the highest in more than four decades.

Europe’s economy has proven more resilient than expected against the headwinds of Russia’s war in Ukraine, including rising energy prices. Unemployment in the eurozone fell to 6.5% in October, a record low. This suggests that the ECB still has work to do to rein in demand.

The euro has already gained about 10 cents to $1.05 against the dollar in the past two months as investors anticipate a pivot by the Fed. The common currency could rise further to $1.15 later next year as the US economy slows and the Fed begins to cut interest rates, according to analysts at Deutsche Bank.

Fed officials have signaled they are preparing to slow after raising interest rates by 3.75 percentage points this year, nearly double the ECB’s two-point hike. After four consecutive 0.75-point increases, investors expect the Fed to raise rates by 0.5 point on Wednesday to a range of 4.25% to 4.5%, then to nearly 5% early next year, before it will cut later in 2023 as the economy slows. However, Fed officials recently indicated that rates could go higher and stay there longer than markets now expect.

ECB officials kept open the option of raising rates by 0.5 or 0.75 point on Thursday from the current 1.5%. The ECB is also expected to unveil plans to begin reducing its multitrillion-dollar bond holdings over coming months, which is likely to push up eurozone bond yields. The Fed has been unloading bonds since June. The Bank of England could unveil either a 0.5 or 0.75 point hike on Thursday, analysts say.

“The ECB cannot afford to lower interest rates next year because the level will be too low. In the US, interest rates are already quite high, so there is room to lower them,” says Joerg Kraemer, chief economist of Commerzbank in Frankfurt. That deviation will depress the dollar, Mr. Kraemer said.

European policymakers are spending heavily to support consumers and businesses as they grapple with prolonged high energy prices and accelerating wage growth. All of which is likely to keep inflation high.

In the US, growth is resilient and the labor market is tight. But the impact of fiscal stimulus is fading, supply chain disruptions are easing, and the prices of goods such as used cars and clothing are falling.

Inflation is likely to be around 6.5% in the eurozone by the middle of next year, compared with around 4% in the US, according to JP Morgan.

Wage growth is heating up in both regions, but while it is still on the rise in Europe, there are some signs that it is softening in the US, falling to an annual rate of 6.4 in November % to slide, according to the Federal Reserve Bank of Atlanta. wage tracker.

In the eurozone, wage growth picked up from an annual rate of 2.5% in 2019 to around 4% in the three months to September, according to Deutsche Bank. Its analysts expect hourly labor cost growth in the eurozone to soon reach 5%, the highest since the early 1990s. In Germany, 40% of businesses say production is hampered by a lack of workers, by far the highest level ever, according to Commerzbank data. Analysts say Europe’s labor market could remain resilient even if the region slips into recession.

Still, uncertainties about inflation’s path are high, partly due to Russia’s war in Ukraine and the unwinding of China’s zero-Covid policy. US inflation may be even tougher than expected as wage growth remains high.

In Europe in particular, interest rates are not yet at levels likely to limit growth and inflation. Real interest rates, adjusted for inflation, are likely to remain deeply negative in Europe next year, but will turn positive in the US early in the year, according to JP Morgan’s forecasts. This means that monetary policy will become increasingly restrictive in the US while remaining stimulative in the Eurozone and the UK

An ECB interest rate close to 3% next year, as investors expect, will not be enough to bring eurozone inflation back to 2%, Mr. Kraemer said. He estimates that the ECB will have to raise rates to at least 4%.

Write to Tom Fairless at

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