Central banks may dash investors’ hopes for a rate cut

Markets have clearly gone too far with their wishes for credit and financial conditions to ease, playing against central banks. The US Federal Reserve (the country’s central bank), the European Central Bank (ECB) and the Bank of England (BoE) will meet this week. Strong labor data, however, is on their side and suggests a reversal of monetary policy is unlikely*.

Leading central banks are preparing to defy investor forecasts for a quick rate cut amid strong jobs data when they meet for the last time this year this week.

Investors are betting

that bankers in the US, the eurozone and the UK will start easing monetary policy at the start of the new year, helping to ease financial conditions for businesses as they argue with falling inflation rates.

But those expectations will be tested in the coming days at meetings of the Fed, ECB and BoE, with all three signaling they want clearer evidence of weakening labor markets before cutting rates.

“They cannot claim victory [над инфлацията] and these data are actually quite useful to counter the market view,” said James Knightley, chief international economist at Dutch financial group ING. “They could very reluctantly give a green light to market expectations.”

The Federal Reserve

which meets this week ahead of ECB and BoE meetings, faces a particularly difficult task amid growing investor speculation that the US central bank will reverse course and cut borrowing costs in 2024 earlier than forecast of the Fed board members themselves. However, they have a longer-term outlook for monetary policy easing amid the need to reduce inflation to the 2 percent target.

Fed Chairman Jay Powell tried to temper those expectations, stressing that it was “premature” to talk about peak interest rates or begin to outline the timing and parameters under which board members would consider cutting interest rates.

The latest economic data supports that argument: data released Friday showed U.S. hiring remained stronger than expected, with the jobless rate falling to 3.7 percent and monthly wages rising strongly.

“Labor markets are holding up better than expected given the movement in interest rates,” said Holger Schmieding, chief economist at Germany’s oldest bank, Berenberg.

The latest U.S. inflation data on Tuesday is also likely to give the Fed a chance to dispel the notion that a policy shift is imminent, Knightley added.

There is some evidence that investors are starting to waver: Friday’s data prompted futures traders to back off bets that the Federal Reserve could start cutting the federal funds rate as early as March. Most now expect monetary easing to begin in May.

Schmieding said the fall in bond yields worries policymakers because “markets want something [по-бързо облекчаване на финансовите условия]which central banks may want to do in six months.”

The ECB and BoE will meet on Thursday

Bankers in the eurozone and Britain are also keen to counter market calls for rate cuts and may point to relatively resilient labor markets as ballast for their arguments.

Unemployment in the euro area remains close to a record low of 6.5 percent, and unit labor costs per hour are rising at the fastest rate since Eurostat began collecting data on this indicator in 1995. At the same time, members of the management of the three big banks say they want to see more evidence that higher labor costs will not trigger a second round of inflationary pressures.

Employers will hold tough collective wage negotiations with unions due to end early next year, including for Germany’s 2.5 million public sector workers, giving bankers reason to resist calls for an imminent rate cut. The ECB’s Isabelle Schnabel said last week that she “will be watching the upcoming wage agreements very closely” as they “will certainly also have an impact on our monetary policy decisions”.

“I think the ECB will want to see evidence that wage growth is matched by inflation falling to 2 percent, and profitability absorbing higher labor costs, before deciding on any rate cuts.” ” said Catherine Naes, a former member of the BoE’s governing board who is currently chief European economist at one of America’s oldest consulting firms, PGIM.

UK wage growth slowed, as did headline inflation, which fell to 4.7% in October. The BoE’s monetary policy committee is expected to keep interest rates at 5.25 percent, the highest level since the financial crisis, at market prices.

“To try to prevent further weakening of financial conditions and to send a signal ahead of New Year’s wage and bonus payments, the BoE is likely to reiterate its ‘higher and longer’ interest rate message,” predicted Andrew Goodwin of Oxford Economics .

*According to Bloomberg and The Financial Times publications.