News of the week summary - 05/07/2023

FED cautiously hints at a pause in rate increases.

Federal Reserve Chair Jerome Powell left open the possibility of future interest rate increases, while emphasizing the seriousness of the central bank's battle against rapid inflation. The Fed recently raised interest rates for the 10th time since last year, bringing its key interest rate above 5%. Powell strongly countered market expectations of rate cuts later in the year by announcing further rate hikes may come if future inflation surpasses his expectations.

The Federal Open Market Committee (FOMC), which controls open-market operations (meaning it implements monetary policy), indicated a potential pause in rate increases without explicitly stating it. This strategy could help prevent investors from interpreting a pause as a sign that the Fed is preparing to reduce rates. The next crucial update will come in June when the Fed is expected to announce its future rate decisions.

In addition, Powell emphasized the importance of raising the U.S. government debt limit and warned against the potentially devastating consequences of the US defaulting on its bonds. Nonetheless, Powell made clear that the Fed does not get involved in negotiations regarding the debt ceiling.

Core inflations slows in the Euro-zone.

The euro area saw a slight easing in core inflation (which excludes volatile products such as energy, food, alcohol, and tobacco in measuring price changes) for the first time in ten months. In April, core inflation increased by 5.6% compared to the previous year, down from 5.7% in March. However, headline inflation (which includes the volatile products) increased to 7%, slightly surpassing analysts’ expectations.

This development may lead the central bank to slow its aggressive interest rate hiking campaign. Arguments for maintaining the half-point pace of rate hikes are weakening, and economists and investors are forecasting a smaller rate increase.

Managing a two-speed recovery, with robust consumer spending on services and a contraction in factory output, is difficult as the ECB tries to fight inflation while avoiding plunging the euro economy into a recession. Concerns still persist about the lackluster property market, rising geopolitical conflicts, and China's slow economic recovery.

European banks tighten credit amid rate increases and turmoil in the financial sector.

Eurozone banks have significantly tightened lending standards, more than anticipated, after an increase in borrowing costs and turmoil in the financial sector. The ECB's Bank Lending Survey indicates substantial tightening in credit standards for loans to firms and house purchases in the first quarter. The decline in net demand from firms was the largest decrease since the global financial crisis.

These findings confirm concerns about the pace of interest rate hikes, especially after the troubles in the financial sector, such as the collapse of Silicon Valley Bank and the takeover of Credit Suisse. The survey indicates that tightening lending conditions primarily result from banks' perception of risks and the ECB's rate increases.