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Global Economic Research

An Active Week For Central Banks

How high do interest rates have to go to control inflation?

It’s rare to have four major central bank meetings within three days, but that’s what we were treated to this week.  The decisions taken will set the tone for the second half of the year.

The Federal Reserve raised its overnight interest rate by 75 basis points on Wednesday.  This was a larger move than they had previewed last month, but it was justified by troubling news on inflation and inflation expectations.  The forecasts released by the Federal Open Market Committee (FOMC) suggested that interest rates would close the year at around 3.5%, significantly higher than their expectations of three months ago.

We now expect the FOMC to raise rates by 75 basis points next month and by 50 basis points in September and November.  Those actions, combined with planned reductions in the Fed’s balance sheet, will certainly tighten financial conditions.  In anticipation, U.S. interest rates have been rising and volatile over the past two weeks.

Fed Chair Jerome Powell was asked during his press conference whether monetary policy can tame the price level, given that so many sources of inflation (war in Ukraine, zero-COVID policy in China) are outside of the Fed’s control.  Increasingly aggressive restraint also raises the risk of a recession next year, although that is not the Fed’s (or our) base case.  Achieving a soft landing “is not going to be easy,” said Powell.

The European Central Bank (ECB) was a surprise entrant to this week’s agenda.  The ECB finished a regularly scheduled meeting last Thursday, but reconvened on Wednesday to address the growing divergence in borrowing costs between member nations.  To combat this kind of “fragmentation,” the ECB will direct more of its bond purchases to peripheral countries in the months ahead.  The intent is to head off debt discomfort in countries like Italy.

The Bank of England (BoE) increased its interest rates by another 25 basis points on Thursday, but is divided on a future course of action.  The outlook for the U.K. economy has moderated, and the main driver of British inflation (the war in Ukraine) is beyond the BoE’s control.  The Bank of Japan meeting was relatively quiet, amid economic stagnation in that country.

Central banks are becoming increasingly aggressive.

The persistence of inflation has caught most observers by surprise.  The increasing aggression of monetary policy to correct it will have a heavy influence on economic and market performance during the balance of the year.  The goal, though, is to sustain conditions that are supportive of both in the years ahead.

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Carl R. Tannenbaum portrait

Carl R. Tannenbaum

Chief Economist
Carl Tannenbaum is the Chief Economist for Northern Trust. In this role, he briefs clients and colleagues on the economy and business conditions, prepares the bank's official economic outlook and participates in forecast surveys. He is a member of Northern Trust's investment policy committee, its capital committee, and its asset/liability management committee.


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