Week ending 28th July 2023.

This week, the focus in the markets was squarely on the key policy decisions from the Federal Reserve (Fed), the European Central Bank (ECB), and the Bank of Japan (BOJ). As widely expected, the Fed and ECB raised interest rates by 25 basis points.

On Wednesday the Fed raised rates taking them to 5.25% – 5.5% despite inflation now standing close to the 2% target at 3%. Fed chair Jerome Powell didn’t appear to change his tune and maintained the long-holding data-dependent stance. While policymakers had previously suggested the possibility of two more rate increases this year during the June meeting, markets have priced in a higher probability that there will be no further rate adjustments for the remainder of the year.

Jay Powell acknowledged that inflation had moderated somewhat since the middle of the last year and that policy was “putting downward pressure on economic growth and inflation”, keeping the possibility open for maintaining interest rates at their current level during the Fed’s next meeting in September, which will be good news for bond and equity markets. There were further signs of cooling inflation in the US after the Core PCE Price Index, the Fed’s preferred measure of inflation, arrived at 4.1% on year in June, down from 4.6% in May and below the market forecast of 4.2%.

Throughout the week, various economic data and indicators pointed to a resilient US economy but also posed challenges for the central banks in managing inflation and interest rates. The US economy surprised by growing faster than anticipated in Q2, adding to hopes that the Fed can deliver a soft landing, with companies continuing to invest in both goods and personnel. GDP increased at a 2.4% annualised rate last quarter, far greater than estimates of 1.8% thanks to consumer spending and increased business investments. Further evidence reinforcing this trend included strong durable goods orders in June and a recent decrease in jobless claims.

The ECB increased the interest rates for the bloc from 4% to 4.25%, the highest level in 22 years. Investors reacted positively as the ECB softened its stance slightly, shifting towards data dependency going forward and saying: “the developments since the last meeting support the expectation that inflation will drop further over the remainder of the year but will stay above target for an extended period”. President Christine Lagarde said officials have an “open mind” and indicated a pause might be on the horizon which satisfied investors.

With inflation in the US and Eurozone running at 3% and 5.5% respectively we believe peak interest rates are a lot closer than policymakers are currently suggesting.

Turning to the BoJ, policymakers maintained negative interest rates but allowed greater movement in the target range for 10-year government bond yields, diluting a key aspect of its ultra-loose monetary policy in order to alleviate downward pressure on the currency. The BoJ’s strategy of maintaining low interest rates has resulted in a widening interest rate gap compared to the US and Europe leading to a decline in the yen’s value. The decision moved markets and led to speculation about more drastic changes in Japan’s ultra-low borrowing costs.

Looking ahead to next week we are expecting, Eurozone GDP & inflation rate. Chinese Manufacturing PMI, BoE interest rate decision, US services ISM and unemployment.

Kate Mimnagh, Portfolio Economist