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Central banks reviewing their monetary policies

Investors were anxious with expectations ahead of monetary policy updates in December, mainly those of U.S. Federal Reserve (Fed) and European Central Bank (ECB). As inflation rate has been dropping both in the U.S. and Europe, many expected interests rate cuts early and it has driven some commodities like gold upwards but as tension rose investors flinched and took profits which has set prices tumbling down from their peaks.

Central banks reviewing their monetary policies

On Wednesday the 13th Fed governor Jerome Powell said that they are done with further interest rate increases but don’t consider cutting them down just yet, even though 17 out of 19 Fed policymakers expect to see lower rates by the end of 2024 while none of them imagine they could go higher, which confirmed the bets made by some traders about early cuts. If the rate drops too fast it could result in severe damage to the economy. It’s also important to keep unemployment low. These tasks are on the Fed’s agenda and sometimes it can be challenging to take on both.

Markets are now factoring in a reduction of 150 basis points in interest rates by December 2024, which is twice the Federal Reserve's forecasts suggesting a 75-basis point cut in the following year. This seems to be overly optimistic according to some. Head of rates and inflation policy at Legal & General Investment Management in UK, Chris Jeffrey, expressed doubts about U.S. monetary policy: “We struggle to work out what kind of world we're in where you have 150 basis points of cuts in the U.S. next year without a recession”. He added that LGIM maintains a positive stance on government debt but is not actively pursuing the rally.

American stocks and indexes jumped after Fed’s statement and USD weakened, most likely also having some impact on prices of oil and gas which has seen positive week after a long period of decline.

Meanwhile, the Bank of England (BOE) stated that UK sees higher inflation than other advanced nations and will need to keep interest rates higher for “as long as it takes”, which goes against expectations on the market that assumed interest rates cuts in 2024. The bank’s governor Andrew Bailey stated that they have successfully pushed inflation rate down from 10% in January 2023 to 4.6% in October, “but there is still some way to go”. However, on the meeting, BOE representatives suggested that it was not an easy decision to make between holding the rates or restraining them. UK paused its interest rates tightening in September 2023 after 14 consecutive increases but stressed that they would need to remain high for a longer period.

Later, Thursday the 14th of December, we saw another highly anticipated report, this time from the ECB. Governor Christine Lagarde in this case, didn’t indicate any early interest rates cuts and said they stick to the original plan of keeping the rates steady throughout 2024 despite inflation in European Union saw quite steep decrease from 4.9 % in September 2023 to 3.6 % in October. After Thursday it was decided that the ECB would hold rates at the same level for a second consecutive time. Lagarde said investors shouldn’t get ahead of themselves despite inflation slumps in recent months reflecting on interest rate cut market bets.

The lowest annual inflation rate in the EU was recorded in Belgium with -1.7%, highest in Hungary with 9.6%. Euro zone inflation was at 2.4% in November. Inflation fell in 22 EU member states and rose in 5. Services made the most significant contribution to the annual inflation rate in the euro zone in October, accounting for +1.97 percentage points.

While inflation seems to be dropping in the world’s biggest economies, central banks remain vigilant with US Fed being the only one to signal early interest rates cuts.

* Past performance is no guarantee of future results.

Sources:

https://www.investing.com/news/economy/fed-likely-to-hold-rates-steady-signal-couple-of-cuts-in-2024-3255540

https://ec.europa.eu/eurostat/documents/2995521/17907993/2-17112023-AP-EN.pdf/ed17ee00-c92c-3bac-8dc7-a4a2bb78074a#:~:text=The%20euro%20area%20annual%20inflation,%2C%20the%20rate%20was%2011.5%25.

https://www.investing.com/news/economy/analysismarkets-outpace-central-banks-as-rate-cut-bets-fuel-everything-rally-3256917

https://www.theguardian.com/business/2023/dec/14/bank-of-england-keeps-interest-rates-on-hold-concern-economy-shrank#:~:text=The%20Bank%20of%20England%20has%20held,base%20interest%20rate%20at%205.25%25&text=Voting%20by%20a%20majority%20of,highest%20level%20in%2015%20years.

https://www.investing.com/news/economy/dollar-feels-the-heat-as-feds-dovish-pivot-weighs-3257147

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