Franklin Templeton Fixed Income talk Fed, BoC, European Central Bank and Bank of England
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The Franklin Templeton Fixed Income (FTFI) Central Bank Watch is a qualitative assessment of the central banks for the Group of Ten (G10) nations plus two additional countries (China and South Korea). See full methodology on page 6.
Latest thoughts on global central bank policy
Federal Reserve
Price stability still the first priority
As anticipated, the Fed delivered another 25-basis-point (bp) rate hike at its March meeting. Not doing so might have raised concerns around banking sector resiliency, the economy or risks that have yet to fully materialize. The Federal Open Market Committee (FOMC) softened its forward guidance, suggesting that “some additional policy firming may be appropriate.” The 2023 median policy rate projection remained unchanged, but that is because the Fed suspects the banking events of March could affect the economy through tighter credit conditions. That in turn could serve as a substitute for rate hikes. The 2024 median policy rate moved up, underscoring the Fed’s higher-for-longer policy. In all, nothing in the FOMC’s or Fed Chair Jerome Powell’s statements has indicated that the Fed’s reaction function has changed. This is still a hawkish and data dependent Fed—it sees no rate cuts this year and could continue hiking if inflation remains sticky and credit conditions do not become particularly binding. While we expect to see some pullback in lending—likely from smaller banks—the still healthy macroeconomic fundamentals will likely only lead to a moderate level of credit tightening. We still expect the policy target range to reach 5.0%–5.25% at a minimum and would not rule out a final 25bp hike at the June meeting if the data warrants it.
Bank of Canada
A pause with conditions
The BoC did indeed hit pause at its March meeting, sticking with its January guidance to pause and assess the impact of past interest-rate increases. However, the bank underscored the conditional nature of its decision, cautioning that either stronger growth or stickier inflation could put rate hikes back on the table. Although the March statement made no mention of the economy being in excess demand, it noted that the labor market still remains quite tight and wage growth elevated. While headline inflation continued to decelerate (to a 13-month low) in February, measures of core inflation remained sticky at just under 5% year-over-year (y/y) and well above the BoC’s 1%–3% target range. Meanwhile, wage growth reaccelerated. However, the BoC expects weaker economic growth over the next couple of quarters to ease wage and price pressures. Therefore, while there may be no underlying reason for the BoC to hike further, we expect it to remain on hold through 2023, barring a major flare-up in the banking sector turmoil.
European Central Bank
Dropping forward guidance, but not the inflation fight resolution
After tumultuous weeks in financial markets and concerns regarding the stability of the banking sector, the ECB stuck with its February plan of raising the deposit rate by 50 bps in March to 3%. The move was intended to signal that the confidence in the European banking system remains high and that no tradeoff exists between financial stability and the inflation fight. The message was widely shared within the Governing Council, with only three or four members dissenting, which gives the idea of the current political balance between hawks and doves. Nevertheless, forward guidance references were entirely dropped for a full shift into data-dependent mode depending on core inflation, banking sector stability, and credit flow developments. Market stress creates uncertainty over an abrupt cutback of credit creation, which is already slowing down due to monetary tightening, but we believe the ECB could easily step in to provide liquidity backstops to banks. While inflation forecasts remain above target through 2025, growth and unemployment projections are tilted toward the optimistic side. We expect the ECB to continue its hiking path as there is “more ground to cover,” although with a more prudent approach in which the size of the next hikes depends on data and with a terminal rate around 3.75%.
Bank of England
Eying the end of the cycle
The BoE hiked by 25 bps in its March meeting, after having raised by another 50 bps in February, bringing the policy rate to 4.25%. The vote split of 7–2 in favor of hiking was in line with consensus expectations, and the meeting minutes struck a balanced tone. On one hand, some comfort was found in the weakening of sequential wage pressures, especially in the private sector, which have remained the most concerning internal inflation driver amid the crippled labor supply. On the other hand, stronger-than-anticipated economic growth, with a recession most likely avoided, and resilient labor demand are seen as risk factors. The banking sector turmoil was also largely dismissed by BoE Governor Andrew Bailey, reflecting a clear operative separation. Another hike in May remains a close call and will intrinsically depend on the next set of labor and inflation data. We suspect that any resilience in employment and sequential wage numbers would tilt the BoE to deliver one last hike to 4.5%, as we previously flagged. Given the structural inflation component hinging on a tight labor market, we do not envisage rate cuts anytime soon.
