Aegon AM: Central banks - what can we expect?

December 9, 2022

Hendrik Tuch, Head of Fixed Income at Aegon Asset Management in the Netherlands, looks ahead to next week’s monetary policy meetings in a new commentary.

After a year filled with rate hikes, the main central banks will have a final message for markets next week. Even though the pace of rate hikes will slow down compared to previous steps, the 50 basis point hikes will still pack a punch.

The US Federal Reserve will probably emphasize that the market expectations for rate cuts next year are premature, as continued tight monetary policy is necessary to cut inflation to normal levels.

The ECB will have to acknowledge that even though European inflation will peak soon, it will likely take years to get core inflation back to its target.

The Bank of England will continue to warn on the downside risks to economic growth, but at the same time raise its official rate to keep (any) inflation fighting credibility. 

Fixed income markets around the world have already started to price in a quick turnaround in monetary policy. That is not helpful at all for central banks at this moment as looser financial conditions are detrimental in their struggle to bring inflation down to more normal levels.

Central banks basically have two instruments to fix this problem. The first is just to continue with rate hikes until markets reprice and financial conditions tighten. The second option is to speed up the unwind of their bloated balance sheets.

Both the Fed and the Bank of England have started to reduce their balance sheets, but at a snail’s pace compared to the buying speed during the Covid crisis. The ECB will announce its own plan for balance sheet reduction in its upcoming meeting this month and it will probably also not be a fast process. 

Financial markets must brace themselves for the increased likelihood that central banks will have to announce additional measures to tighten monetary policy. The upcoming December meetings are probably not the best time to shock financial markets, as liquidity in markets is already low before year end. But the start of 2023 might see renewed central bank hawkishness, which in combination with slowing economic growth does not make for a great start of the year.