The end of a cycle

“The Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target.” With this statement, taken from the press release accompanying its latest monetary policy decision, the European Central Bank made it abundantly clear that the 0.25% rate hike on 14 September will almost certainly be the last in the tightening cycle. It is a position that will no doubt be echoed by the Federal Reserve (Fed) in the US. The Fed’s next meeting is scheduled for 19 and 20 September, and is not expected to see a rate hike. And while slight doubt persists about the November meeting, it seems likely, going by the latest macroeconomic data, that its rate-hiking cycle is already over. Earlier this month, Australia’s Reserve Bank kept its policy rate unchanged for the third consecutive time, and it too seems to have turned the page on monetary tightening. And the list goes on. After a year and a half of steadily rising interest rates, the cycle appears to be complete for the world’s central bankers.

But the perils aren’t behind them yet. Initially, central banks will maintain their policy rates at today’s elevated levels, delicately balanced on a precipice. They will be assessing whether the inflationary storm has indeed run its course and seeking to avoid being thrown off balance by the gusts of economic slowdown that are growing stronger by the month. This uncomfortable situation could soon be confronting the ECB, which has revised down its economic growth expectations for 2023 and 2024 substantially. The German economic engine slipped into recession in the second quarter, household consumption is sluggish throughout the eurozone, and the business outlook is lacklustre, despite a persistently robust job market.

Across the Atlantic, things look simpler for the Fed at first glance. Most investors expect the central bank to succeed in curbing inflation, while allowing the economy to make a soft landing. But in reality, the US economy is on very shaky ground. After surging thanks to the massive post-Covid stimulus plans, it is now faced with three perils: consumption is poised to slow sharply in the coming months, fiscal support is set to decline and the job market is starting to crack.

Faced with these clouds gathering on the economic horizon, central banks will quickly have to starting thinking about bringing down their rates – or risk being caught at the summit in a blizzard. There are two possible scenarios. Ideally, inflation will continue to ease without the economy coming to too sudden a halt. That would allow central banks to start gradually lowering interest rates so as to keep real rates close to neutral. But in a more pessimistic scenario, the economy could eventually run out of steam, forcing central banks to resume their role as insurers by activating various mechanisms as needed to slow the decline… and ensure that the landing is as smooth as possible.

Dated 15 September 2023 – Enguerrand Artaz, Fund Manager