Central banks across Europe pause for breath after giant rate hike, but face ‘triple dilemma’

High inflation continues to affect European households and businesses, and the region’s central banks have yet to declare victory in bringing it to target.

But September marked a change in tone in their messaging, as some central banks put the brakes on interest rate increases after almost two years, while others appeared to be on the verge of their maximum rates. This has focused market attention on how long rates will remain at current levels, amid strains on economic growth.

This month’s decisions have shown that “all central banks face the same triple dilemma: how to balance slowing economies, still too high inflation and the delayed impact of unprecedented rate increases,” said Carsten Brzeski, head of global macro of the Dutch bank ING. he told CNBC.

“The other common theme is, of course, that in all regions interest rates are very close to their maximum, which complicates the dilemma described above.”

The recent rising oil prices poses an additional headache, he added, that could fuel inflation while slowing economic growth, and making future interest rate decisions even more difficult to make.

The Bank of England chose to take a break The interest rate moves after 14 consecutive increases, maintaining its main policy rate at 5.25%.

It was a close decision, with five members of the Monetary Policy Committee voting in favor of maintaining and four in favor of another 25 basis point increase. It is possible that the decision was made by a August inflation impression lower than expectedwhich showed headline year-on-year inflation of 6.7%, well above the BOE’s 2% target, but below the 7% forecast.

The central bank also noted signs of easing in the labor market, stability in wage growth and weaker economic growth for the second half of the year. He UK economy contracted 0.5% in July as the number of late mortgage payments jumped to a seven-year high.

While BOE Governor Andrew Bailey said the committee would be “watching closely whether further increases are needed,” many economists said they expected this to represent the bank’s top rate.

Paul Dales, chief UK economist at Capital Economics, said that like the US Federal Reserve, which also kept rates steady in September, the BOE “wants markets to believe the highs narrative for a long time.”

“The Bank does not want markets to decide that a spike in rates will soon be followed by rate cuts, which would relax financial conditions and undermine its attempts to quell inflation,” Dales said in a note on Thursday.

While Capital Economics forecasts the rate cuts will be implemented by the end of 2024 and will be “deeper and faster than expected”, HSBC economists see no declines on a 15-month horizon. Meanwhile, Simon French, chief economist at Panmure Gordon believe It is too early to make reliable predictions about the timing of the first interest rate cut, given the lack of “parameters for easing.”

The Swiss National Bank opted for a break for the first time since March 2022, saying in a statement that “the significant tightening of monetary policy in recent quarters is offsetting remaining inflationary pressure.”

Inflation in Switzerland reached 1.6% in August, within the national target range of 0-2%.

However, SNB Governor Thomas Jordan told CNBC that “the war on inflation is not over yet,” adding that the Swiss central bank would continue to monitor inflation pressures. This could mean further adjustment in December, Jordan stressed.

Analysts described the SNB’s latest decision as an “aggressive pause” given continued caution and no signs of cuts on the horizon despite Switzerland’s economic stagnation in the second quarter. The country’s economy is forecast to register an average growth of 1% for the year.

The SNB forecasts that annual Swiss inflation will average 2.2% in 2023 and 2024, and then 1.9% in 2025, assuming its policy rate remains at the current level of 1.75%.

By contrast, some described the European Central Bank as “moderately hiking” on September 14, when high rates by 25 basis points, although it suggests they may have peaked.

“The Governing Council considers that the ECB’s official interest rates have reached levels which, maintained for a sufficiently long period, will make a substantial contribution to the timely return of inflation to the target,” the ECB said in a statement, adding that the rates “shall be set at sufficiently restrictive levels for as long as necessary.”

The ECB expects growth of just 0.7% in the euro zone this year and 1% next, compared to almost 2% expected for the United States in 2023.

Market prices suggest a more negative economic outlook and the expectation that the central bank may be forced to make cuts by the middle of next year as a result.

The euro has fallen 1.7% against the US dollar so far this month, marking its worst performance since February. The drop came even though interest rate increases typically boost the value of a currency.

In northern Europe, Norway and Sweden opted to raise rates on Thursday and suggested there could be further tightening in the future.

But a hint of maximum rates was also found in these decisions: Ida Wolden Bache, governor of Norway’s Norges Bank, said that “there would probably be a further increase in policy rates, most likely in December.”

Bache added: “It will probably be necessary to maintain a strict stance for some time.”

Norway’s headline inflation rate was 4.8% in August, with core inflation at 6.3%.

Norges Bank’s forecast now indicates a policy rate of 4.5% through 2024, up from 4.25% currently.

Like other central banks, it signaled uncertainty in its outlook, noting that inflation pressures and a weak krone could prompt it to raise rates further. Meanwhile, a “steeper slowdown” in the economy or a rapid drop in inflation could translate into a lower rate.

Sweden’s Riksbank separately said inflation was still too high and monetary policy needed to be tightened further as it raised its main rate to 4%.

The Swedish krona currency has reach historic lows against the euro in recent months. Sweden’s central bank said on Thursday it would cover part of its foreign exchange reserves to deal with what it sees as undervaluation.

Sweden has also experienced a serious crisis in the real estate market, and the Riksbank projects that the national economy will contract by 0.8% this year and 0.1% next. This led Capital Economics to predict rate cuts before the middle of next year, “earlier and faster” than the Swedish central bank had announced.

However, ING’s Brzeski noted that the dual forces of inflationary pressures and weaker growth could lead to a different outcome, given the difficulty of future decisions for all central banks.

“Central banks most concerned about their credibility and the long-term impact on inflation expectations, such as the ECB and the Riksbank, could end up continuing to raise rates,” he said.