Navigating the shifting sands of global interest rates
Last week, there were a multitude of intriguing discussions surrounding the always-fascinating topic of interest rates. Lisbon, Portugal played host to a meeting of the minds, attracting an array of esteemed individuals from the European Central Banking circles, all gathered to dissect and predict the movement of interest rates.
ECB's president, Christine Lagarde, is confidently predicting that hikes won't rest anytime soon. Her views echo those of Philip Lane, ECB's Chief Economist, who throws caution against rate cuts over the next two years. It appears we should brace ourselves for another potential rate hike from 3.5% come July, with September shaping up to be a momentous month for deciding whether to persist with these hikes. Both Lagarde and Lane seem to favour continued rate increases, warning against cutting rates in the next two years.
There are some intriguing numbers to consider so far. EU's headline inflation has dipped to 6.1% in May (down from 7%), while core inflation, which sets aside the unpredictable elements of food and energy, stands at a year-over-year rate of 5.3%. The ECB is still aiming for a 2% target, suggesting that their current strategies are beginning to leave a mark.
Shifting our attention across the English Channel, the situation in the UK echoes a similar sentiment. The governor of the Bank of England, Andrew Bailey, anticipates persistently high rates, with the UK markets seemingly preparing for further interest rate hikes. While the general market expectation may be for a short-lived peak in interest rates, the undeniable fact remains that inflation pressures in the UK are stubbornly refusing to ease off. As a result, interest rates by year-end are forecasted to hit 6.25%, a rate not seen since 1999.
In the US, the Chairman of the Federal Reserve, Jerome Powell, echoes a similar sentiment. He mooted the possibility of another half percentage point increase by the end of 2023, though he also highlighted the need to give time for the effects of 10 straight rate hikes to this weeks Fed Fund rate of 5.25%, to permeate through the economy. While some suggest these rate hikes may push the economy into a downturn, Powell views this outcome as possible but not the most likely scenario.
Interestingly, the US banks passed recent stress tests, but these did not account for the potential continued rise in interest rates, instead operating under the perhaps overly optimistic assumption of a reversion to zero interest rates.
Taking a closer look at the Irish landscape, we see some intriguing developments. Despite Ireland's position as a small, open economy, the ERSI recently adjusted its economic forecast to an expected growth of 0.1% in GDP, a sharp dip from the 5.5% projection in March. This drop is attributed to reduced global demand feeding into export activity, with pharma-related goods being especially affected. The substantial influence of pharma exports on Ireland's GDP also highlights our dependency on multinational companies. However, a couple more quarters may be needed to discern whether this decline is a broader trend or just a temporary blip.
It's important not to let these headlines cloud our judgment. Let's touch upon an often overlooked but crucial factor: The ERSI points to the Modified Domestic Demand (MDD), a more reliable gauge of domestic economic conditions, which is expected to grow robustly by 3.5% this year and 4% in 2024. This promising outlook serves as a beacon of hope amidst potential gloom, reminding owner-managers not to fixate on negative headlines. Instead, we should scrutinise the data for the bigger picture and maintain a long-term perspective. A pessimistic spiral won't nurture innovation and growth. Additionally, the ERSI expects inflation in Ireland to decline to 5% this year and further to 3% next year, which is promising compared to global inflation rates.
In a nutshell, as business owners scan the horizon, Ireland's underlying economy seems resilient. Housing completions are predicted to improve in 2024. Nevertheless, business owners need to keep a careful eye on the effects of rising interest rates, adopting a cautious approach that encourages growth and development. It's crucial to stay positive, steering clear of negativity is essential, as poor decisions now could jeopardise a business's potential to thrive in the current economic cycle.
For further reading see the article links below:
https://www.theguardian.com/business/2023/jun/28/high-interest-rates-persist-bank-england-governor
https://www.cnbc.com/2023/06/28/fed-stress-test-2023-23-banks-weathered-severe-recession.html