Central Bank rhetoric remains hawkish, with policymakers determined not to repeat last year’s mistake of underestimating inflation. From their perspective, the ideal would be a mix of slower, but positive economic growth, avoiding the pitfalls of a deep recession, while keeping a close eye on the target inflation rate. This would allow them to proceed cautiously, biding their time and recalibrating policy gradually to align with the underlying economic fundamentals. It should also herald a return to normal policy behaviour after the recent period of frenzied tightening as central banks fought to regain credibility.
The main shift in our thinking – and one which we expect gains traction in the market is the recognition that a recession may not be needed in order to move inflation back towards its target over the next year. Instead, the reversal of post-pandemic upheaval alone may prove sufficient to bring about a positive inflationary outcome. While Central Banks may still tighten their policies a bit further from here, the end of the rate-hiking cycle seems well within reach as long as the current positive trend continues.
However, there seems to be no pressing reason for Central Banks to embark on an easing cycle anytime soon, but this doesn’t mean that markets will sit on their hands. As ever, they will adapt their strategies in line with policy changes and, keeping a close watch on such developments, we will reflect this within our own asset allocation through an adjustment in risk.
Perhaps on one level, policymakers should secretly be pleased that banks and companies have emerged relatively unscathed from the rapid cycle of monetary tightening, and that the efforts to re-engineer balance sheets have proven to be a success.
As we move forward the key takeaway is that Central Banks are approaching the end of the rate-hiking cycle, offering hope for a more stable economic environment with controlled inflation. Policymakers’ cautious approach and financial institutions’ resilience signal a potential return to normal policy behaviour.
To find more about the latest house views from London & Capital’s Investment Desk, read the full AndPapers Q3 2023 here.