Markets have rallied on the signs that borrowing costs have peaked.

Despite Jerome Powell, the US Federal Reserve Chairman saying that ‘price rises still need to be kept under control’ the Federal Open Markets Committee held US interest rates at 5.25- 5.5% range in their November meeting.

The US economy has been growing faster than expected and the Fed has faced criticism that rising rates to what is now a 22 year high, could put the US economy at risk. Despite high interest rates the US economy grew by 4.9% in Q3. This was a significant boost, helped by a strong jobs market and improved consumer spending.

By holding rates, the Fed will pause to review the good economic data before making its next move. Mr Powell said that the Fed was very aware that rate rises were hurting households and businesses, but inflation at 3.7% stands above the Fed target of 2% and that the ‘US has a long way to go in the battle to get inflation back to 2%.’

The Fed is clearly pleased that the economy has grown at the same time inflation has fallen due to high interest rates. They do not need to retain high interest rates longer than is necessary but do want to ensure that inflation is controlled.

A useful indicator of the market perception of the strength of the US economy is the yield on long term bonds. 10-year bond yields have risen recently hitting a high of 5.0% on 19th October. These yield rises have also prompted this pause in rate rises which has in turn then prompted a reduction in yields, as markets now expect rate cuts in 2024. US 10-year yields are now trading at 4.4%.

The Federal reserve followed the ECB who also kept their interest rates on hold at 4.5% on the back of inflation falling to 2.9%. There are concerns within the ECB that Eurozone growth is weak and that further interest rate rises would be counterproductive.

The ECB have been criticised for its past rate rises as Eurozone inflation is below 3% partly due to falling energy costs. Higher interest rates have led to a decline in growth as GDP fell by 0.1% in Q3. The demand for new bank loans has fallen sharply as has mortgage demand as lending criteria heightens and credit supply falls. Analysts are predicting a -0.5% fall in GDP in Q4 and that growth will not return until Q3 2024. Italy’s UniCredit Bank feels that the ECB have tightened more than is needed as inflation was falling and growth turning negative.

Fidelity shares the view that ECB rates may be now higher than the economy can take, if they stay at this 4.5% level. If the ECB persists with higher for longer ‘the implications could be a deep recession.’ The criticism of the ECB is that the Bank is too willing to sacrifice growth as they are so focussed on inflation. Fidelity expects Christine Lagarde to have to cut rates in Q1 2024 much sooner than Ms Lagarda herself has indicated.

Some analysts have suggested that central Bankers at the ECB have not faced a cost-of-living crisis of this nature before and so have no experience of how far rates need to rise or how long it takes for borrowing costs to feed through to the real economy.

Oxford Economics feel that over the next year, developed economies will be impacted by higher rates and will need to cut early and rapidly.

The Bank of England (BoE) also left interest rates unchanged at the MPC meeting in November. Sluggish economic growth and signs that the UK job market is slowing down have led to calls for a halt on interest rate rises. UK unemployment is now 4.2%.

The BoE have been raising rates since December 2021 to bring down inflation. UK inflation peaked at 11.3% in October 22 and now stands at 4.6%. It is predicted to fall further but remains a long way off the BoE target of 2%. The BoE will have to balance the need to bring inflation down as this has such an impact on the cost of living by keeping rates high which will hurt household borrowers and business lending. UK inflation remains much higher than Europe at 2.9% and USA at 3.2%.

Andrew Bailey, the BoE Governor has said that there are ‘increasing signs that higher interest rates are starting to hurt the UK economy’

Fidelity is worried that if the BoE keep interest rates on hold, then the UK may also pay a price in terms of growth as well as the Eurozone. The Institute of Economic Affairs has called on the BoE to start cutting rates to avoid a recession.

The fact that the BoE, Fed, and ECB all put interest rates on hold in the same first week of November, has increased optimism that the global cycle of interest rate rises has come to an end. It shows that higher interest rates have driven inflation down and if held for a period longer should continue to reduce inflation.

With the UK economy slowing and unemployment rising in the face of these high interest rates, the US has been able to perform much better with significant economic growth and a strong jobs market. US unemployment is 3.9%

Jerome Powell has stated that reducing US inflation is likely to require a period of lower growth and some softening of the labour market. Despite some softening in the labour market, the Fed feel that a recession in the US is not likely. Traders took the sign that borrowing costs had peaked and markets rallied throughout November on this outlook.

The S&P 500 started November at 4237 points and hit 4559 on Friday 24th November, a rise of 7.6%. All other major markets saw meaningful rises too.

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