The Month Ahead

Equity markets had an up-and-down August, with benchmarks in the US and New Zealand giving up some early solid gains. The mid-month sell-off in equities came as bond yields moved higher as interest rate markets priced in more aggressive tightening by the world’s central banks. During the month, the yield on both the US and New Zealand 10-year government bonds hit eight-week highs.  

September is a central bank-heavy month, and with inflation in some parts of the world showing little signs of slowing, further increases in policy rates are all but a sure thing, with the main question being, how big will some central banks go. 

As usual, we start with the world’s largest central bank, the US Federal Reserve, which meets on 21 September, where investors remain split on a 50 or 75 basis point hike. After Fed Chair Jerome Powell delivered a relatively hawkish speech at the Jackson Hole economic symposium, saying the central bank must “keep at it until the job is done” (referring to raising interest rates to slow inflation), interest rate markets shifted towards a greater likelihood of a 75 basis point hike. However, when questioned on the size of the next rate hike, Powell did say economic data would be a factor in this decision, but he also noted “restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy”.

While inflation remains a key focus when assessing the outlook for monetary policy, employment data is becoming just as important in the Fed’s pursuit of a ‘soft landing’ – the scenario where inflation drifts back towards the Fed’s target rate without the unemployment rate rising too high. 

The employment conundrum is twofold: The Fed would like to see continued employment growth, but recent wage price increases are posing a challenge to slow inflation. Given this, the latest US employment report released on 2 September, will be closely watched. 

The Bank of England (BoE) is perhaps in the biggest bind of all developed central banks with inflation showing signs of entering a spiral amid surging energy prices. In August, the central bank said it expects inflation to peak at 13%, but further increases in energy prices mean inflation could peak even higher. 

Also concerning for the BoE, interest rate increases have yet to slow the pace of inflation, with year-on-year inflation rising every month dating back to October 2021. This serves as a good example of how central bank monetary policy does not influence the non-core elements of inflation such as oil and food prices.

Nevertheless, it is expected the central bank will forge ahead with another 50 basis point hike this coming month (it would be just the second 50 basis point hike in nearly 30 years), despite the risks it poses to economic growth. 

The uncertainty around the war in Ukraine meant the European Central Bank (ECB) was later than most in lifting interest rates to combat inflation. But now, after its first hike in more than a decade, the central bank is likely to raise its deposit rate by another 50 basis points this September. 

There has been a rift among policymakers at the ECB regarding the appropriate path of monetary policy, and recently, ECB board member Fabio Panetta said the economic slowdown would “mitigate inflationary pressures” hinting it could lessen the need for central bank action – a stance that is out of line with many board members. 

Nevertheless, interest rate markets remain firmly in the camp of another 50 basis point hike, which would take the deposit rate above zero for the first time in more than a decade. 

Finally, the Reserve Bank of Australia (RBA) is set to increase its policy rate by 50 basis points as rising wages and tight labour market conditions are underpinning inflationary pressures. This comes after economic data in August showed the unemployment rate fell to 3.4%, its lowest level since the 1970s.

Finally, in New Zealand, GDP data released on 15 September could show that the country fell into a recession in the second quarter, defined as two consecutive declines in economic growth. 

It was expected that the economy would have had a solid pick-up in the second quarter, but retail sales data released in August showed sales fell 2.3% in the June quarter, after a 0.9% decline in the first quarter of 2022. The fall in retail sales was well below most forecasts (the RBNZ had expected a jump of nearly 2%) and now raises the possibility of back-to-back quarterly declines in GDP growth.