How will the recent bank drama affect Federal Reserve policy?

How will bank failures affect Federal Reserve policy?

Before the collapse of Silicon Valley Bank over a week ago, investors were betting that the US Federal Reserve would raise interest rates by 0.5 percentage points at its March meeting, forced to reaccelerate the pace of tightening after recent strong jobs and inflation data.

But the outlook for the Fed is no longer so clear. The drama in some parts of the US banking system has suggested to investors that the central bank is done, or nearly done, with its monetary tightening. Although the banking issues have little to do with inflation, a shift towards more aggressive policy could lead to panic in markets and more problems with banks, which in turn would require further intervention from the Fed.

Pricing in the futures market currently suggests that most investors are expecting the Fed to lift rates by 0.25 percentage points when it meets on Tuesday and Wednesday. Those expectations have been shifting rapidly, however, and earlier this week, the chances of any hike at all were near zero.

The meeting comes after inflation data showed that consumer prices continued to cool in February, though the improvement was smaller than economists had anticipated. The CPI index rose 6 per cent in February, year over year, with core inflation — which strips out the volatile food and energy sectors — up 5.5 per cent. Kate Duguid

Which way will the BoE ‘knife-edge’ decision go?

Economists say the next monetary policy decision by the Bank of England, on Thursday, is a “nail-biter”. Governor Andrew Bailey has already opened the door to a pause in increasing policy rates, but inflation remains stubbornly high.

Markets have priced in an almost equal probability of a 0.25 percentage point increase and no change.

The BoE has raised its policy rate at every meeting since November 2021, when the benchmark rate was at a historical low of 0.1 per cent, to the current rate of 4 per cent.

The economy is feeling the impact of rising borrowing costs and the cost of living crisis, contracting in the third quarter and stagnating in the last three months of 2022. Turbulence in the banking sector with the collapse of Silicon Valley Bank last week has added to investor concerns over the impact of rising borrowing costs on the banking sector and activity.

However, inflation is still in double figures and the labour market remains tight, fuelling economists’ fears of more persistent price pressures.

Elizabeth Martins, an economist at HSBC, said the move is “a nail-biter, but on balance, we think the BoE will press on and hike to 4.25 per cent.”

She added that UK inflation data for February, which is released on Wednesday, the day before the policy meeting, could still change the outcome of the vote. Weak price pressure would tilt the decision to a no change.

“Whether the Bank hikes or not next week, we think it is approaching the end of its tightening journey, for now at least,” Martins added. Valentina Romei

Will the eurozone economy remain resilient?

The eurozone economy is expected to show further resilience in the face of the cost of living crisis, with a leading business survey forecast to show activity continuing to expand in March.

Economists polled by Reuters expect the flash eurozone composite purchasing managers’ index, a closely watched barometer of private sector activity, to come in at 52 in March. This would be unchanged from February and above 50, which indicates a majority of businesses reporting an expansion compared with the previous month.

The PMIs, released on Friday, are expected to show that eurozone growth was driven by services, with that sector index expected to come in at 52.6, largely unchanged from the previous month. Manufacturing, which has been severely affected by high energy prices, is forecast to still be in contraction but marginally better than in the previous month.

Ryan Djajasaputra, an economist at Investec, said that in February the eurozone PMI showed improving confidence, rising demand in the service sector and a continued easing of supply chain pressures. He expects that “this trend continued in March”.

That would be in line with expectations of improving activity forecast by the European Central Bank.

“The economy looks set to recover over the coming quarters,” ECB president Christine Lagarde said at a press conference on Thursday after announcing a 0.5 percentage point increase in the deposit interest rates.

“Industrial production should pick up as supply conditions improve further, confidence continues to recover, and firms work off large order backlogs,” she said. “Rising wages and falling energy prices will partly offset the loss of purchasing power that many households are experiencing as a result of high inflation.” Valentina Romei