Rate hikes everywhere
Crushing inflation (and the economy)
Interest rates have increased nearly everywhere. They increased by 75bps in the US, UK, and Europe and by 25bps in Australia. The clear goal is to address inflation. Let’s look at some of the major happenings:
Federal Reserve
The Federal Reserve increased rates by 75bps at its November meeting. The market had largely anticipated this rate hike. And, indeed, the stock market increased modestly during the start of the trading day. However, the market reacted negatively to Jerome Powell’s speech. Why?
The market’s main concern is that Jerome Powell appears to have become more hawkish. He indicated that the overarching goal is to lower inflation to 2%. He appeared indifferent towards whether this increased unemployment, which is implicit in lower economic growth. He appeared miffed at the possibility that stock prices might increase and financial conditions might loosen. Chair Powell noted that the Federal Reserve has ‘some ways to go’ in its rate high course, suggesting continued aggression and a higher Fed Funds rate than initially anticipated.
Reserve Bank of Australia (RBA)
The RBA increased its policy rate by 25 bps. This takes the cash rate to 2.85%. This is relatively low compared with other countries. However, there are several key differences between Australia’s situation and that of other locations:
Australia’s inflation rate is lower than that of peer nations. CPI inflation in Australia is measured quarterly and was 7.3% in September. While the RBA has flagged a possible increase to 8%, this is still below the US (8.2%), Europe (10.7%) and the UK (10.1%).
Australia’s debt exposure is different, especially for consumers. In the US, mortgages are often 20-to-30 year fixed rate mortgages. Many refinanced to low rates during 2020 and 2021. This insulates borrowers from rate increases. By contrast, mortgages are generally variable in Australia, with only a short-term fixed rate period available. Many fixed rate mortgages will shift to variable rates in 2023. Australian mortgages often tend to be larger than US mortgages. Thus, a similar rate hike has a larger impact in Australia than it does in the US.
Australia had different fiscal stimulus from the US. In Australia, fiscal ‘stimulus’ was primarily to offset lockdowns. It did not generally make consumers wealthier than they would otherwise be. By contrast, in the US, lockdowns were less punishing and stimulus came in the form of cash payments. This created a greater cash buffer.
The rate increases nevertheless have had a negative impact on property prices. They have reduced the price people can afford to pay for properties, and cooled the property market, which had increased significantly during 2020 and 2021.
Bank of England: United Kingdom
The Bank of England increased the policy rate by 75bps to 3%. This is the largest rate hike in decades. This is to address soaring inflation of 10.1%. This was especially the case for food and energy. The rate hike was part anticipated.
The Bank of England also flagged that inflation will remain elevated and a recession could be prolonged into 2023 and 2024, with only slow GDP growth thereafter. This caused the pound to fall significantly.
European Central Bank (ECB)
The ECB increased rates by 75bps. European inflation is running at 10.7%, with several member countries seeing inflation above 20%. Europe faces greater challenges than do the US and Australia. Europe’s economic growth appears likely to slow significantly: GDP only increased 0.2% last quarter. While this was higher than expectations (0.1% Q/Q) it is lower than the prior reading (0.8% Q/Q).
The ECB is thus hiking into weakness. This weakness appears likely to worsen. Jamie Dimon – the CEO of JPMorgan Chace – has indicated that the EU is likely already in a recession or will be soon. High energy costs, an over-reliance on gas stockpiles, and increasing food costs appear set to reduce European economic growth.