Fidelity: Central banks should not tighten further

June 29, 2023

Anna Stupnytska, Global Macro Economist at Fidelity International, comments on the panel discussion during today's ECB Forum on Central Banking.

'Going into the event, central bankers - the Fed, the ECB and the BoE - were expected to stress that inflation remains too high meaning they are not done hiking yet, in line with their latest communication. The Sintra panel's messaging was overall in line with expectations.

Chairman Powell came across as quite balanced around his hawkish stance, emphasising that rates have not been in restrictive territory for very long, meaning more transmission of tighter policy is yet to come. At the same time, he also acknowledged some signs of softening in a number of labour market indicators but stressed that risks of not doing enough to tame inflation are still somewhat higher than risks of doing too much - though they are becoming more balanced. He noted the Fed has not taken moving at consecutive meetings off the table.

President Lagarde kept her messages closely aligned to her opening remarks earlier in the conference and in the ECB's June press conference, stressing the bank has more ground to cover, while maintaining their data dependent, meeting-by-meeting approach. She signalled a hike in July is very likely but refused to give any more guidance beyond that.

There had been more focus on Governors Bailey and Ueda in the run up to the event, with market participants hoping to get more clarity on the respective central banks' current thinking, given the BoJ's outlier status in terms of policy (in)action relative to other central banks and in light of BOE's surprise 50bp hike last week.

Ueda stuck to the BoJ's relatively dovish stance emphasising that despite some indicators of inflation running above target, its underlying measures remain below 2% and wage growth is still too low to be consistent with the inflation target. As we expected, Ueda emphasised that policy makers are focused on what happens to inflation in 2024, looking to gain greater confidence that inflation is not going back down below target, before deciding to change their policy stance.

Governor Bailey stressed UK's core inflation remains persistent due to the tight labour market which is primarily explained by the pandemic-related dynamics. He also noted that the policy transmission mechanism is possibly slower than it used to be due to the structural change to the UK mortgage market, meaning uncertainty about the timing and the magnitude of policy transmission is abound.

Looking ahead, as the DM central banks continue to feel the heat of persistent inflation, we expect their rhetoric to remain hawkish, sending the message that rates will not only go higher from here and also stay at those restrictive levels for some time.

As policymakers focus on lagging indicators of inflation and unemployment, and taking into account long lags in the transmission mechanism, we believe there is already enough tightening in the system to push economies into recession in coming months. Notably, this is in contrast to central bankers' and consensus expectations - Powell, Lagarde and Bailey all said at the Sintra panel that risks of recessions remain but this is not their base case.

As rates go even higher from here, that path towards a potential soft landing is becoming extremely narrow, in our view - and thus unlikely. Depending on the nature of those recessions, and especially on how the financial systems fare in that environment, some - if not all - central banks might have to resort to a rapid course correction and cut rates earlier and faster than they are currently expecting. But for the time being, the Fed, the ECB and the BoE are very much in the 'higher for longer' camp.