The US Federal Reserve raised its target rate by 50 basis points on Wednesday, a move that was its biggest in over 20 years but still managed to just meet market expectations.
The target range for the federal funds rate is now 0.75-1%. It last rose by 50bps in 2000, to reach 6.5%.
Across the pond, a day later, the Bank of England (BoE) also met market expectations by hiking its base rate by 25 bps to hit a 13-year high of 1%.
There was no other choice
Hinesh Patel, portfolio manager at Quilter Investors, said the move from Britain’s central bank “resembles shuffling deck chairs on the Titanic”.
“As was widely expected, the BoE has once again had no choice but to hike rates in its attempt to contain inflation at an appropriate level, this time to 1%. This marks the fourth consecutive rate rise since the BoE began its fight against inflation back in December 2021 when it first raised rates following the pandemic, and the bank rate now sits at a level not seen since the aftermath of the financial crisis in early 2009.
“Inflation hit a 30-year high of 7% in March, and the BoE predicts it will hit just over 9% during the second quarter and likely higher still in the second half of the year, averaging slightly over 10% at its peak in 2022 Q4. Given this, the BoE had no choice but to increase rates further still. It is continuing to build in some insurance now should there be a slowdown in economic growth or the jobs market stumbles. With the significant economic impact of the Russia-Ukraine war alongside a multitude of other global risks and plunging consumer confidence, growth will no doubt be challenged and the Bank may be forced to stop tightening even as soon as this year.
“For now, however, it must continue on its path to prevent sterling devaluing further and intensifying the household squeeze. Savings rates could improve following this rate rise, though will only be marginal offset the cost of living crisis currently being faced. With the Fed moving harder with rates yesterday evening, many will have hoped to have seen the same from the BoE today. With inflation continuing to soar, the Bank risks doing too little too late.
“While the BoE may be putting up a confident front, given the current delicate market environment, we could easily see inflation continue to rise above the BoE’s forecasts. Investors will need to continue to watch the data and markets closely and allocate accordingly. Diversification, active management and prudency remain key.”
Divisions emerge in Montary Policy Committee
Luke Bartholomew, senior economist at abrdn, said: “While the decision to hike rates by 25bps to 1% was widely expected, the composition of votes and the large forecast changes has given investors a lot to digest. The Monetary Policy Committee seems to be divided at least three ways, with three of the nine members voting for a 50bps hike, while a further two members disagree with the Committee’s assessment that further rate hikes from here will be necessary.
“These divisions reflect just how difficult it is to set policy at the moment, with the economy facing multiple conflicting shocks. The bank has revised its inflation forecasts higher, while it is now expecting a small contraction in the economy in 2023.
“This is a toxic economic combination, which requires the Bank to make difficult trade-offs over how much it prioritises supporting growth or bringing inflation down. Part of the division in the MPC can therefore probably be accounted for by different policy makers assessing this trade-off slightly differently. All this means it will be remain difficult to extract a clear signal from the Bank about where interest rates are likely to eventually settle, which is likely to be a source of ongoing volatility.”
Rapidly changing investment landscape
Marc Reale, wealth manager at Wilton, said: “Rising interest rates have become a rare certainty in a sea of uncertainty. 2022 is shaping up to be a battle of nerves that will put many people’s financial judgement to the test. Do you lock down the cost of borrowing and utilities now, at prices which would have seemed expensive until recently, or bide your time in the hope that events will turn and run the risk of falling foul of future rate hikes?
“Economic optimism is far harder to come by than most people hoped for, even with the pandemic subsiding. Many households and business owners are in new and unchartered territory when it comes to managing their finances. But it’s important to look past the gloom and remember that borrowing costs remain low by any sensible definition of ‘historic standards’.
“The flipside of today’s rise is that investors will be seeking higher returns than they’ve been willing to settle for while interest rates flirted with zero. The landscape for investment and borrowing decisions is changing rapidly and financial planning can’t afford to be seen as a once-a-year exercise in the current climate.”
Ongoing increases planned in America
Meanwhile, in the US, the minutes of the Federal Open Markets Committee (FOMC) reveal that the Russian invasion of Ukraine and the highly uncertain implications for the US economy were contributing factors to the record rise.
Further supply disruptions from Covid-19 lockdowns in China were also cited.
In support of its goal to return inflation to 2%, the FOMC “anticipates that ongoing increases in the target range will be appropriate”.
“In addition, the committee decided to begin reducing its holdings in treasury securities and agency debt and agency mortgage-backed securities on June 1.”
This will involve a runoff of $30bn (£24bn) and $17.5bn in treasuries and mortgage-backed securities, respectively, rising to a combined $95bn by September.
Fixing a policy mistake
Fidelity International’s global head of macro and strategic asset allocation, Salman Ahmed, described the Fed’s overall tone as “hawkish”. “But, critically, chair [Jerome] Powell ruled out scope for 75 basis point hikes for now. Further 50 basis point hikes remain on the table over the next two meetings.”
Ahmed believes the Fed will hike “less than market expectations, but for now the hawkish stance is likely to remain intact given the strong state of the labour market and inflationary dynamics”.
He said the Fed “made a policy mistake last year by letting inflation run out of control, and as a result, it could be walking a narrow road for some time as it looks to balance the tightening path without creating an accidental recession”.
Aggressive hikes to come
Federate Hermes senior economist Silvia Dall-Angelo said Powell “conveyed a sense of urgency with respect to addressing high inflation”.
“While Powell reiterated his belief there is a decent chance of achieving a soft-or softish-landing, they rarely happen. It will be difficult for the Fed to calibrate the right amount of tightening, given it is starting from behind the curve.”
She expects the Fed will continue “to hike aggressively in the next few months, as inflation could remain sticky at uncomfortably high levels despite having probably peaked.”
Unlikely to deviate from its path
Gurpreet Gill, macro strategist, global fixed income at Goldman Sachs Asset Management concurs.
“We think the Fed will frontload its hiking cycle, ultimately moving the policy rate to a neutral setting of between 2-3% this year,” she said.
“Growth looks resilient, despite GDP in the first quarter falling short of expectations. In this context, the Fed is unlikely to deviate from its path of ‘expeditiously’ aggressive tightening until it reaches a neutral policy setting.”
A pivotal year
But BRI Wealth Management CEO Dan Boardman-Weston warned that “current cost of living pressures combined with higher interest rates means that the growth outlook for the US is gloomier than it has been since the dark days of Covid”.
As such, “the Fed has a difficult balance act” ahead, he said.
“A large portion of the inflation continues to be supply driven and interest rate increases are not going to assist with these contributory factors to inflation. 2022 will be a pivotal year for monetary policy and the risks of a misstep and a hard landing seem to be increasing.”
