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Leading central banks are preparing to push back at investor predictions of how quickly interest rates will fall, as they meet for the final time this year amid strong employment numbers.
Investors have been betting that policymakers in the US, the eurozone and the UK will start loosening monetary policy early in the new year, fuelling an easing in financial conditions for businesses, as they focus on falling headline inflation readings.
But those expectations will be tested in coming days at meetings of the US Federal Reserve, the European Central Bank and the Bank of England, all three of which have signalled they want clearer evidence of weakening labour markets before cutting rates.
“They can’t declare victory [over inflation], and the data is actually quite helpful to push back against the market narrative,” said James Knightley, chief international economist at ING. “They will be very, very reluctant to give the market the green light.”
The Fed, which gathers ahead of the ECB and BoE this week, faces a particularly challenging task amid increasing investor speculation that the US central bank will reverse course and lower borrowing costs earlier in 2024 than officials had suggested would be necessary to bring inflation down to its 2 per cent target.
Fed chair Jay Powell has sought to temper those expectations, stressing it was “premature” to say interest rates had peaked or to begin sketching out the timing and parameters under which policymakers would consider cuts.
Recent economic data reinforces that argument: figures published on Friday showed that US hiring remained stronger than expected, with a fall in the unemployment rate to 3.7 per cent and solid monthly wage growth.
“Labour markets are holding up better than expected given what interest rates have done,” said Holger Schmieding, chief economist at Berenberg.
Fresh US inflation data due on Tuesday is also likely to give the Fed cover to dispel the notion that a policy pivot is imminent, Knightley said.
There is some evidence that investors are beginning to waver: Friday’s figures prompted traders in futures markets to scale back their bets that the Fed could start slashing its policy rate as early as March. Most now expect it to begin in May.
Schmieding said that falling bond yields were a concern for policymakers because “markets are [easing financial conditions], which the central banks may want to do half a year later”.
The ECB and BoE both meet on Thursday. Policymakers in the eurozone and the UK are also anxious to counter the market’s rate-cutting narrative, and can point to relatively resilient labour markets as ballast for their arguments.
Eurozone unemployment remains close to a record low at 6.5 per cent and unit labour costs per hour worked are rising at the fastest pace since Eurostat records began in 1995. With price growth in the eurozone’s labour-intensive services sector still running at 4 per cent, rate-setters say they want to see more evidence that higher labour costs will not drive a second round of inflationary pressure.
Several large rounds of collective wage bargaining with unions are due to conclude early next year, including for 2.5mn German public sector workers, giving policymakers a reason to push back against calls for imminent rate cuts. Isabel Schnabel at the ECB said last week it was “going to watch upcoming wage agreements very closely” as these “will certainly also matter for our monetary policy decisions”.
“I would think the ECB will want to see evidence that wage growth is consistent with inflation falling to 2 per cent as well as profit margins absorbing higher labour costs before they decide on any rate cuts,” said Katharine Neiss, a former Bank of England official and now chief European economist at PGIM Fixed Income.
Indicators of UK wage growth have eased and so has headline inflation, which dropped to 4.7 per cent in October. The BoE monetary policy committee is widely expected to hold rates at 5.25 per cent, the highest since the financial crisis, according to market pricing.
“To try to prevent financial conditions loosening further and to send a signal ahead of the new year pay round, the [BoE] will likely double down on its ‘high for longer’ message,” said Andrew Goodwin of Oxford Economics.