Brace for rate hikes and tapering from BoE and Fed

Just as the dust settled on Chancellor Rishi Sunak’s third budget, the City turned its attention to more set piece economic announcements.

Today and tomorrow, the US Federal Reserve and the Bank of England will deliver two of the most hotly awaited interest rate decisions in years.

The latter is expected to hike interest rates 15 basis points, while the former is likely to announce a reduction of around $15bn of its enormous bond buying programme.

On the face of it, the two central banks could pull the exact opposite monetary levers to rein in stimulus launched in response to the pandemic.

Fed Chair Jerome Powell will signal that tapering is not a precursor to rate hikes, while the Governor of the Old Lady Andrew Bailey could do the exact opposite if the Bank’s rate setting committee decides to plough on with the final leg of its QE programme.

As always, predicting the movements of central banks is for the birds.

However, the best place any onlooker can turn to for clues to peg their judgement on how a central bank will act is in the rhetoric of its top brass.

Hawkish language by several members of the BoE’s rate setting committee has ramped up in a remarkably short space of time. Governor Andrew Bailey has gone from defending loose policy to reinforcing the Bank’s willingness to “act” if medium term inflation expectations spiral out of control.

Recent signalling from the Governor has been “fairly blunt – he wants to act, and sees little point in waiting,” analysts at ING think.

New chief economist – and Andy Haldane’s successor – Huw Pill gave an interview with the FT in which he stressed the need for ultra accommodative monetary support has “diminished”.

Some members remain dovish. Catherine Mann has suggested the Bank does not need to raise rates because financing conditions have already tightened as traders brace for a higher interest rate environment – the so-called “Maradona” theory.

Meanwhile, Fed chair Jerome Powell has struck a more cautious tone, underlining his commitment to achieving maximum employment in the American economy. For him, rate hikes are “a ways off”.

Signals projected by the BoE and Fed have triggered a steepening in gilt and treasury yield curves, driven by markets adjusting to the reality of tighter policy.

As a consequence, the transition to higher borrowing costs is already in motion, regardless of what the central banks do.

But, neither likes to surprise markets, meaning they would have pushed back on speculation over tightening by now if it was not imminent.

“The BoE will surely find it hard to not follow through with a November hike having talked the market, deliberately or not, into pricing it,” experts at Bank of America said.

Strengthening bets on earlier rate rises from officials on Threadneedle Street have primarily been driven by the inflation tiger proving harder to catch than thought.

The Office for Budget Responsibility expects price rises to peak at 4.4 per cent next year. In a worst case scenario it has it hitting around eight per cent, which may prompt the Bank to raise rates above three per cent.

A wage/price spiral emanating from the jobs market is a headache for both the Fed and the BoE.

Bank of America expects Powell “to underscore that if the Fed sees the risk of inflation moving persistently higher, the Fed won’t hesitate to use its policy tools to guide inflation back to two per cent.”

It is important to distinguish between immediate inflation and inflation expectations. If the latter were to increase, expect a succession of rate hikes from the BoE.

“If inflation expectations continue to rise as the MPC is raising rates, the MPC may want to raise rates further to get ahead of the curve,” said Paul Dales, chief UK economist at Capital Economics.

A larger state, funded through swelling tax burdens in both the UK and US, is set to squeeze households’ living standards. Brits and Americans will feel the pinch even harder from higher mortgage and borrowing costs.However, the Fed and Bank of England’s main remit is to keep inflation in check. That is exactly what they will focus on.