The Fed has raised rates, the ECB has tightened policy and the Bank of Japan is set to follow, raising fresh questions over whether global interest rates are heading into a new phase.
For much of the past two years, financial markets were waiting for major central banks to cut interest rates. That story is now getting more complicated. The US Federal Reserve has raised interest rates, the European Central Bank has tightened policy for a second time this year and the Bank of Japan is expected to raise rates on Friday.
The moves are being driven by persistent inflation risks, higher energy prices and concerns that price pressures may remain above central banks’ targets for longer.
The question for global markets is whether these moves mark the beginning of a new rate-hike phase or whether central banks are responding to different economic problems at the same time.
Fed turns towards higher rates
The Fed raised its benchmark interest rate by 25 basis points on Wednesday to a range of 3.75 per cent to 4 per cent. It was the first US rate increase since 2023.
More importantly, the Fed’s latest projections point to another increase. Sixteen of the 18 policymakers see at least one more 25-basis-point hike this year.
Fed Chair Kevin Warsh said inflation remained too high and that underlying price pressures had not shown enough improvement. Strong US economic data has also reduced the urgency for the central bank to support growth through lower borrowing costs.
More from BusinessThe US economy has therefore moved into an unusual position. Growth remains resilient while inflation is proving difficult to bring down. That gives the Fed more room to keep rates high.
US retail sales rose 1.2 per cent in August, beating expectations. Core retail sales increased 1.4 per cent. The data reinforced the view that consumer demand remains strong enough to withstand higher borrowing costs for now.
ECB has already tightened
Europe is also moving in the opposite direction from the rate-cut story that dominated markets earlier.
The European Central Bank raised its deposit rate by 25 basis points to 2.5 per cent on September 10. It was the ECB’s second rate increase this year.
The reason is similar but not identical to the US. Higher energy prices have pushed inflation above the ECB’s 2 per cent target. The central bank expects euro zone inflation to average 3 per cent this year.
Markets are now preparing for the possibility of further increases. Germany’s 10-year government bond yield recently reached its highest level since 2011, reflecting expectations that interest rates could remain higher for longer.
But the ECB also faces a growth problem. Higher rates can bring down inflation, but they can also weaken demand at a time when the European economy remains fragile.
Japan could be next
The Bank of Japan is expected to raise its policy rate on Friday. A 25-basis-point increase would take rates to a level not seen in about 31 years.
Japan’s move is different from the Fed’s. For years, Japan operated with extremely low interest rates. The BOJ is now gradually moving away from that policy as inflation becomes more persistent and the domestic economy adjusts to higher prices and wages.
The expected hike also matters for global markets because the yen has traditionally been used to fund so-called carry trades. Investors borrow cheaply in yen and invest in higher-yielding assets elsewhere.
If Japanese rates rise and the yen strengthens, some of those trades can become less attractive. That can affect bond markets and risk assets beyond Japan.
What about the Bank of England?
The UK shows why it may be too early to describe this as a coordinated global rate-hike cycle.
The Bank of England is expected to leave its policy rate unchanged at 3.75 per cent on Thursday. UK inflation rose to 3.1 per cent in August, largely because of higher energy and transport costs.
Markets are nevertheless watching for the possibility of future increases if energy prices keep inflation elevated.
The UK’s situation highlights the difficult choice facing central banks. Energy prices can push inflation higher while simultaneously hurting household spending and economic growth.
Is a new global rate-hike cycle really beginning?
The recent moves are important, but they do not mean that all major central banks are following the same path.
The Fed is responding to persistent US inflation and resilient demand. The ECB is dealing with an energy-driven inflation shock. Japan is gradually moving away from years of ultra-low interest rates. The Bank of England is still weighing high inflation against weak labour market conditions and softer growth.
The bigger change is in market expectations. Investors had increasingly assumed that the next major move by central banks would be a rate cut. That assumption is now being challenged.
