Will central banks keep raising interest rates in 2023?

(Image credit: Federal Reserve – )

The decisions of the central banks usually trigger significant reactions on the financial markets, no matter what kind (currencies, stocks, bonds, etc.). Indeed, central banks are the ones that determine the monetary policies of the countries concerned, generally to ensure price stability in their economies.

They therefore vary the amount and cost of money to achieve their goals of helping or slowing economic growth to prevent it from overheating and inflation from accelerating too much. These decisions therefore influence the purchasing, saving and investment decisions of the various economic actors such as companies or households.

In 2022, when global inflation soared, central banks responded by raising interest rates significantly. But will they be able to keep raising rates so aggressively in 2023?

What criteria do central banks use to decide when to raise interest rates?

The majority of central banks aim to maintain price stability in their respective economies (typically reflected in medium-term inflation of around 2%). Therefore, inflation numbers are one of the criteria most commonly used by central banks to vary their interest rates.

The US Federal Reserve (the Fed) has a dual mandate of price stability and full employment. It is therefore important to also consider other criteria, in particular the resilience of the labor market and the trajectory of economic growth.

But that also applies to other central banks, because their actions should not (too much) impede growth prospects. That’s the fight the majority of central banks are fighting today: fighting runaway inflation by raising interest rates enough without plunging their economies into recession.

Global inflation overview

As a reminder, inflation corresponds to the sustained and general rise in prices, generally measured by the consumer price index (CPI).

While most developed countries are targeting a 2% CPI, the war in Ukraine has pushed up the prices of many energy and agricultural commodities. And with food and energy being two main categories of inflation, price increases in many countries have hit records not seen in several decades.

According to Eurostat figures, the annual inflation rate in the euro zone reached 10.7% in October 2022. In the same period, it reached 7.7% in the United States and 6.9% in Canada. In September 2022 annual inflation reached 7.3% in Australia and 7.2% in New Zealand. Although the situation in Japan is not that worrying, October inflation reached 3.6%, a record high since 1982.

Outlook for monetary policy in 2023

With inflation, your dollars aren’t worth what they were a year ago today. In comparison, you couldn’t buy the same amount of goods or services today as you could with the same amount a year ago. This means that the higher the inflation, the more it eats away at your purchasing power. So high inflation changes your purchasing decisions, but also your savings and investment decisions because you no longer have the same purchasing power.

As we have just seen, inflation in many leading economies is well above the 2% inflation target. However, this level is seen as the level that allows central banks to better achieve their goal of price stability while supporting their economic growth in the best conditions.

In order for inflation to return to more reasonable levels, central banks have decided to raise their key interest rates in 2022 and they should continue to do so until inflation approaches levels that are considered “more reasonable” and “sustainable”. . However, it is important that the growth outlook does not deteriorate too much due to rate hikes.

Today there are many uncertainties regarding the development of the macroeconomic landscape. The end of the conflict in Ukraine still seems far away. The consequences of the sharp rise in energy prices could continue to weigh on households and companies for a long time to come. And the impact of the recent rate hikes on economic activity is still uncertain.

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