With the Bank of England’s announcement today (June 22) that its benchmark interest rate is set to rise to 5% – the thirteenth consecutive increase in borrowing costs since December 2021, and a bigger than expected rise – this is an opportune moment to look at what other central banks are doing and to consider whether we have entered a new era of permanently higher interest rates.
Last week (June 14), the Federal Reserve held their key rate in a target range of 5%-5.5% but indicated that further rises might come later this year, as the US also seeks to tame inflation. And the following day, the European Central Bank announced an interest rate rise of 25 basis points, taking its main rate to 3.5%.
Similarly, both the Reserve Bank of Australia and the Bank of Canada restarted rate hikes at the beginning of June having paused for a couple of months, setting rates 4.10% and 4.75% respectively.
What is the thinking behind these rises, and are they here to stay?
It is worth reading a speech [Hyperlink ‘speech’: https://www.bankofcanada.ca/2023/06/entering-new-era-higher-interest-rates/] given by Paul Beaudry, Deputy Governor of the Bank of Canada, earlier this month (June 8), where he spelled out his thinking in plain terms to the Canadian people: “I won’t claim to know with certainty where interest rates are going, but I can point to where some of the risks lie. By doing this, I am hoping to help Canadians prepare in case it turns out we have indeed entered a new, higher interest rate environment.”
Beaudry’s remarks give a good indication of where most developed central bank thinking is coalescing on the likely medium term destination of interest rates. “The risks appear mostly tilted to the upside. In the Bank’s view, that makes it more likely that long-term real interest rates will remain elevated relative to their pre-pandemic levels than the opposite.” Read in tandem with Christine Lagarde’s speech in mid-April [Hyperlink ‘speech’: https://www.ecb.europa.eu/press/key/date/2023/html/ecb.sp230417~9f8d34fbd6.en.html], which gives a good insight into current ECB thinking, a clear picture emerges that the higher interest rate environment is here to stay.
There was clearly a hope at the beginning of the year that inflation would firmly be on a downward trajectory by the summer, allowing interest rates to follow soon after. And whilst they were likely to take some time to get back to pre-pandemic levels, the interest rate hikes of 2021/22 were a temporary measure. This no longer seems to be the case. Higher interest rates seem set to stay.
With the Fed placing a temporary pause in interest rates hikes, the ECB and BoE continuing their ‘rate hike programme’ as part of their monetary policy in the quest of getting inflation down to target levels, we are seeing that both EUR and GBP are rallying against the greenback aggressively with EUR/USD reaching a yearly high last month breaking the 1.10 barrier for the first time this year.
As for cable, sterling has shown strength against the dollar, achieving a year high last week of 1.2827. Longer term in 2023, we see EUR/USD stabilising around the 1.08 mark with cable consolidating at 1.30 by the end of the year.