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Central banks lower curtain on era of minimal interest rates

The Bank of England has met market expectations by announcing a quarter-point rise in interest rates from 0.75% to 1% in a bid to curb resurgent inflation.

The Bank’s monetary policy committee (MPC) has already sanctioned 0.25% hikes at its February and March meetings, having begun raising rates last December, from an emergency level of 0.1% - introduced early in the Covid-19 pandemic - to 0.25%.

The UK rate was last at 1% at the start of March 2009, when it was halved by the BoE to 0.5% in the wake of the global financial crisis and a quantitative easing (QE) programme was launched.

The move comes a day after the Federal Reserve raised the US benchmark rate by half a percentage point to between 0.75% and 1%, its largest rise since 2000, and Fed chairman Jerome Powell said that further 50 basis-point increases would be “on the table” at upcoming rate setting meetings.

Fed policymakers also approved plans to reduce its holdings of Treasury and mortgage securities from 1 June, which will be cut by US$47.5 billion a month over the summer.

Susannah Streeter, senior investment and markets analyst for UK financial services company Hargreaves Lansdown, notes that “relief has rippled” through financial markets at the news as the Fed seems committed to keep to the path it has mapped out in trying to tame resurgent inflation.

‘’Financial markets have become hooked on the drug of cheap money and policymakers are clearly keen not to induce a shock for the economy, by weaning dependents off too rapidly and that’s reassured investors. The 0.5% interest rate hike may have been the biggest in the US since 2000 but it was a move already priced in by the markets. Rolling back the mass stimulus programme by offloading bonds from Fed’s balance sheet will start on a more gradual incline than some feared at US$47 billion a month, before rising.

“Remarks by Jerome Powell soothed tensions further indicating a steeper 0.75% rise wasn’t on the cards right now for hikes in the summer, with a more gradual edging up of rates expected. But it’s not completely out of the game plan, as the Fed wants to stay nimble in the face of rapidly changing circumstances.”

Deutsche Bank's research strategist Jim Reid said that the Fed “intentionally or unintentionally decided that the market has had enough stress for now and clamped down on the more hawkish potential near-term paths for policy.”

The Economist magazine struck a less positive in a lead article earlier this week, suggesting that Wall Street was unprepared for the imminent shrinkage of the Fed’s balance sheet and could even result in a seizing up of the market for Treasury bonds as it becomes a smaller player.

Commenting on the BoE's latest move, Streeter added: "The Bank is still taking a softly-softly approach when it comes to rolling back its huge bond buying stimulus programme to avoid tantrums in the bond markets in the form of spiking yields which would make borrowing much more expensive.

"It’s kicked the roll back of its quantitative easing programme into the long grass, with only an update planned at the August meeting on whether to start sales."

This week has also seen the Reserve Bank of Australia (RBA) announce the country’s first interest rate increase since November 2010 – a 0.25% hike from 0.1% to 0.35%, which was a steeper rise than markets had been expecting. In addition, the Reserve Bank of India (RBI) raised the repo rate - at which it lends money to commercial banks - by 40 basis points to 4.4%, having trimmed it to a record low of 4% during the Covid-19 pandemic.

RBI governor Shaktikanta Das made the surprise announcement during an online media briefing yesterday. The RBI also announced a 50 basis point increase in the cash reserve ratio - the percentage of cash required by banks to keep in reserve against their total deposits - to remove excess liquidity from the system.

Bucking the recent trend has been the Central Bank of Russia, but only because it had implemented an emergency increase in its key rate from 9.5% to 20% in late February to shore up the rouble following Russia’s invasion of Ukraine. However, the currency has subsequently recovered, resulting in two reductions, first to 17% and then to 14% at the end of last month.

Russia’s inflation rate reached 17.6% in April and is expected to peak at between 18% and 23% this year, before returning to 5% - 7% next year and its 4% target rate in 2024.

The European Central Bank (ECB) has indicated that it plans to adopt a more gradual approach to interest rate increases, although executive board member Isabel Schnabel has indicated that a hike could be announced in July. The ECB said last month that it will end net asset purchases under its Asset Purchase Programme (APP) in the third quarter of 2022.

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