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In recent weeks, the combination of relatively softer inflation and moderate (but higher than anticipated) growth have strengthened market views that central bank policy rates are approaching their peaks and have turned attention to the possibility of monetary easing, without an intervening recession.

Policymakers will seek to balance growth uncertainties with the need to return inflation durably to target by emphasising the tightness of monetary policy over time. What matters is not just the terminal policy rate but also the time it stays there. The monetary stance is, after all, an integral (or area) concept.

Expectations matter: central banks will use different media to shape the message to remove reflexive market expectations of near-term policy easing and keep policy restrictive without causing excessive impacts on household cash flows or business confidence. Emphasising the integral of monetary policy will help economies slow, not stall.

The US Fed Funds rate will likely top out at 5.50-5.75% and remain there through to next summer, before only gradually declining at a 25 basis points per quarter pace.

The European Central Bank is balancing a more hawkish reaction function than the Federal Reserve, with a weaker economy. This should yield two more rate increases, with a terminal rate of 4% held into the middle of next year before a careful easing begins. We expect Quantitative Tightening to continue throughout.

With the highest inflation and the least anchored monetary expectations, the Bank of England will need to deliver several 25bp hikes this autumn to reach a 5.75% terminal rate. Depending on the reaction of UK consumers, policy could begin to ease starting next summer.

The Bank of Japan has been the leader in using the integral of monetary policy to influence economic activity and inflation, but now it must make the difficult pivot from easing to tightening. Regular upward revisions of inflation forecasts will help justify policy normalisation in the latter part of 2023 and early 2024, ultimately lifting the overnight rate to 1% by the end of 2024.

Despite better-than-expected economic performance in the US and equity market enthusiasm, most indicators suggest that a slowdown will take hold towards year end. Although inflation has slowed, it remains 2 percentage points above target and the tightness in labour markets remains sufficiently extreme that it is hard to see how inflation can be fully tamed without a rise in unemployment. The key takeaway is that with the economy needing to operate below potential for an extended period monetary policy needs to be tighter for longer.

However, this strategy will support conditions for the fundamental driver of medium-term growth – an investment boom driven by the response to new geopolitical realities, the accelerating energy transition, the AI revolution and the renewed prioritisation of resilience.

This is an abridged version of a client note. For more information, Contact Us.