News in Charts: The end of the rate hiking cycle in the US and the UK?

Is the end of policy hikes around the corner? Potentially, yes, after this week’s rate-setting meetings by two of the largest central banks, the Federal Reserve and the Bank of England. In its meeting on 20 September, the Fed’s Federal Open Market Committee agreed to keep the federal funds rate unchanged in the range of 5.25% to 5.5%. A day later, and following an inflation release that surprised to the downside, the Bank of England’s Monetary Policy Committee too decided to stall its key policy rate, at 5.25%.

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The Fed’s decision prompted little surprise. Indeed, 96.9% of economists in a September Reuters poll believed that the Fed would leave rates unchanged on 20 September, due to US core inflation continuing on its downward trajectory. Although the headline inflation increased to 3.7% in August on a year-on-year basis after a couple of flat months, that increase was down to volatile components, specifically food prices, which spiked last month. Stripping inflation from these components leaves an annual core inflation figure of 4.3% in August, a 0.3 percentage point decrease compared to July. Those patterns (even the increase) are still broadly consistent with the 3.6% target analysts expected for 2023, something that prompted commentators to stick with their call of a likely Fed pause.

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Nevertheless, there are still some alarming figures regarding US inflation. On a monthly basis, the US headline CPI (seasonally adjusted) increased by 0.6%. This was driven by gasoline prices, which increased by 10.6% in August. Core CPI also increased, by 0.3% — driven by an increase in rent and owners’ equivalent rent, among other things.

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In terms of the US labour market, the unemployment rate increased by 0.3 percentage points to 3.8% in August. If joblessness continues to increase, it would mean that the US is moving away from a very tight labour market, easing inflation by reducing the pressure for increased wages. On the other hand, if the labour market remains tight, this will put upward pressure on inflation and interest rates.

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By contrast, the UK’s decision to hold its rate was much less expected. Before ONS inflation data surprised to the downside on 20 September, consensus opinion had been 80% behind a further hike. But the ONS release showed that the headline inflation rate, as measured by the 12-month percentage change in CPI, was now at 6.7%, a decrease of 0.1 percentage points compared to July, and  0.4 percentage points below expectations in the previous MPC meeting. The largest negative contribution to UK CPI was a decrease in food prices and accommodation services, which tend to be volatile; whereas the largest upward pressure came from rising motor fuel prices. Annual core CPI rose by 6.2% in August, a decrease of 0.7 percentage points since July; and services annual inflation was down 0.6 percentage points in August compared to July, at 6.8%. Core and services inflation are closely monitored when looking at the long-term inflation outlook. The MPC expects headline inflation to fall in the near term, on the back of lower energy, food and core goods inflation. However, the committee also expects services inflation to remain elevated in the short run.

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Although UK inflation may have just surprised to the downside, the UK is still experiencing the highest inflation rate among the G7 countries. Furthermore, wage growth is less consistent with the 2% inflation target in the UK than in the US. Strong wage growth in the UK is one of the reasons why the Bank of England may have to tighten further — public sector pay increased 7.2% in July compared to the year before, whereas private sector pay increased 7.9% year on year, down from 8.3% in June.

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Compared with the US, inflation appears less under control in the UK. Whether further UK rate increases are necessary will depend on the labour market and services inflation. As for the Fed, a pause in rate hikes, and even cuts in the policy rate, are now on the cards. The Fed too will be guided by the labour market in its decisions. The FOMC is emphasising that the job is still far from done – in its latest forward guidance, it still indicates one more rate hike this year, followed by a 0.5 percentage point cut in 2024, with upward revisions to growth and expectations of a steady low unemployment rate. This could mean that the US escapes a high inflationary period with few job losses and avoiding recession — a soft landing, perhaps?

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The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.

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