The Hard Decision Facing Central Banks

Next week the Federal Reserve, Bank of England, and Swiss National Bank all meet. This time last week the SVB crisis was just dropping onto markets and since that time the decision for central banks has just got a lot harder. The fall out from the Credit Suisse crisis on Wednesday just underscored the difficulty for central banks now.  Do they hold back on hiking interest rates due to strains in the economy? Or do they keep hiking so inflation doesn’t get out of control?
Invariably in markets someone always thinks a central bank has ‘got it wrong’. In an ideal world, with hindsight, all decisions can be made with 20/20 vision. It’s easy looking backwards to know what decision you should have made. However, in reality it is usually more down to luck than skill when timing is perfect in these decisions. That does not take away from the difficulty of their decision though and here are some of the factors influencing them

The lag effect

Is the SVB crisis and Credit Suisse the first signs of economic activity being crushed. The answer is, ‘yes’. So, the next question is how many more banks will be affected. If the Fed hike rates by 50bps next week will there be more banks under strain. Will investors start moving deposits from ‘riskier’ banks? The risk of contagion is real and when it happens, it happens very quickly.

The inflation fight

It’s not over. So, with the Fed backing up the SVB and the SNB supporting Credit Suisse will this type of ‘propping up’ keep global inflation pressures rising? If they don’t hike rates, does the core inflation rates around the world just keep rising? Core rates have been generally quite stubborn around the world. The US core was 5.5% for February

The UK’s core inflation was 5.8% for January

The Eurozone’s core inflation was 5.6% for February and is still trending higher

So, the risk is that the core inflation becomes entrenched if the central banks take their foot off the gas too quickly in terms of raising rates. However, what is ‘too fast’? The drop in the labour market numbers post covid has kept wages firmer, so price pressures are still ‘in the system’.

The importance of next week

The pressures on central banks underscore the importance of next week and also the next moves for markets. After huge amounts of rate re-pricing over the last 7 days one thing is for sure – expect volatility next week over the Fed’s meeting. Watch stocks and precious metals closely as some near term trends could be set depending on how aggressive or otherwise central banks decide to be.