Central banks are hawkish but growth is a concern

Fed

Central banks are hawkish as they battle rampant inflation. The Federal Reserve was unphased by the -1.4% Q1 contraction (+1.1% forecast) and hiked rates on 4 May by 50bps. Fed Chair Jerome Powell also prepared the market for another 50bps in June and July. He took 75 bps off the table for those meetings.

However, as we noted in a previous article, the Fed is still behind the market regarding rate expectations. Moreover, employment costs are high, with the Employment Cost index printing at 1.4% for the quarter. Therefore, if inflation continues to rage, we suggest that 75bps may still be in play. The problem for the Fed is that its fight against inflation has a high chance of negatively impacting economic activity.

BoE

The Bank of England has hiked four times since December, with its key Bank Rate now at 1%. The BoE's statement is essential, which forecasts double-digit inflation at 10% by Q4 2022, but that "UK GDP growth is expected to slow sharply over the first half of the forecast period." We note that three of the nine MPC members dissented, opting for a 50bps increase instead of the 25bps we got.

Given this and the commentary, we assess that there was some thought for the BoE to front-load so that future hikes are smaller than market expectations. Although hikes are expected, these will taper off, i.e., dovishness has crept into the central bank's thinking. The GBPUSD sold off viciously as a result.

ECB

The ECB is well behind in terms of its pivot in monetary policy. However, there is a growing expectation that the ECB will raise rates sooner than later. Governing council hawks have been vocal, and the doves are ready to capitulate. ECB chief economist Philip Lane and board member Fabio Panetta are now open to raising rates in the following months.

This pivot comes as eurozone inflation hit 7.5% in April. Moreover, the vicious decline in the EURUSD in 2022 will further inflation. The July meeting thus becomes interesting for a potential hike and the start of the ECB's cycle, albeit with a lower amplitude than other regions. This limit is because of the added complexity of the region. Southern European countries hold more government debt and are likely to resist rate increases into 2023. Moreover, being so reliant on Russia for its energy makes the region a higher risk for stagflation.