Weekly Update - Central Banks: Close to the pic but the pivot should still wait
The Fed and the ECB raised their key rates by another 25bp to 5-5.25% and 3.25-3.75% respectively. While Mr. Powell suggested that this increase was probably the last in the up-cycle, Mrs. Lagarde suggested that the ECB will continue its up-cycle in future meetings. In an environment where activity remains resilient, inflationary pressures remain high and in the absence of greater stress on the banking system, monetary conditions should remain tight in 2023.
Federal Reserve: likely pause pending inflation and banking tensions. As expected, the Fed raised its key rates by 25bp to 5-5.25% at its May meeting and maintained its pace of balance sheet reduction at $60bn per month in Treasuries. We also expect this to be the last rate hike in this tightening cycle and that the Fed will keep rates at 5-5.25% for the next few quarters. Indeed, in its statement, the Fed dropped references to further rate hikes, and Mr Powell insisted in his press conference that this was a significant change. In addition, the Fed estimated that restrictions on credit conditions linked to regional banking tensions would slow demand, thus justifying a halt to the upward cycle. Finally, at the press conference, Mr. Powell noted that the rapid rate hikes, combined with the balance sheet reduction and tightening of credit conditions, put monetary policy in a "sufficiently restrictive" position.
ECB: a reduction in the rate of increase but the peak not yet reached and an acceleration of the reduction of the balance sheet. The ECB also raised its key interest rate by 25bp to 3.25-3.75% at its May meeting, thus reducing the pace of increase. However, it decided to accelerate the pace of balance sheet reduction by ending the reinvestment of securities under the Asset Purchase Program (APP). 27 billion per month. Unlike the Fed, the ECB confirmed in its press release and press conference that the monetary tightening cycle would continue. Indeed, the communiqué states that the level of monetary policy is not yet "sufficiently restrictive to bring inflation back to 2% in the medium term" while Mrs. Lagarde stressed that the reduction in the pace of rate increases does not mean a pause in the monetary tightening cycle. Finally, unlike the March meeting, there was no mention of possible banking tensions in Europe.
A tightening peak near but a pivot to wait. If central banks have indeed reached or are on the way to reaching their terminal rate, money markets expect them to start cutting interest rates as early as this summer. In the US, markets expect a start to rate cuts as early as September, with a key rate at 4% by January 2024. In the Euro area, markets expect a further 25bp increase and the start of a rate cut in January 2024. In the absence of a more pronounced crisis in the US regional banks or the occurrence of other financial tensions, we believe that central banks should maintain rates at these levels in 2023. On the one hand, economic activity remains resilient on both sides of the Atlantic, with consumption still robust in the US, while business surveys in Europe suggest a rebound is underway. On the other hand, underlying inflationary pressures still remain high, with a decline that would remain very gradual in this activity context.
Finally, in the main events of the week, we have chosen to talk about the bank lending conditions in the Euro area and to focus on the US labour market.