Increases in base rates are almost a daily occurrence right now – much to the detriment of equity markets. Just last week, the ECB confounded all hopes by raising interest rates again. The key deposit rate that banks receive from the central bank for parking surplus money climbed from 3.75% to 4.00%, the tenth hike within the space of little more than two years. The USA can look back on as many as eleven increases to date – and there may be more to come. Although the domestic currency watchdogs in Switzerland has been turning the interest rate screw a little less tightly, here to there have already been five upticks since June 2022, with interest rates rising from -0.75% to 1.75% now.
The measures come on the back of a long period of galloping inflation. Although it has probably already passed its zenith and been on the downward slope in the last few months, inflation is still well above the level targeted by the monetary authorities. The ECB made it clear after its latest meeting that it would stick by its mandate to deliver price stability and would consequently keep interest rates high for as long as necessary to force inflation down. “An interest rate cut is not on the agenda,” said president Christine Lagarde. The ECB is not alone with this strategy, however: both the SNB and the Fed also want to maintain the purchasing power of money and are aiming for an inflation rate of no more than 2%. With interest rates in the eurozone having reached their highest level since the currency union launched in 1999, attention is now turning to the Fed and SNB. They will reach their monetary policy decisions following the summer break on 20 and 21 September (after we go to print). Before the meeting the Fed’s Funds Rate stood at 5.25% to 5.50%.
Things will get interesting in the USA especially, where there has recently been an unexpected countermovement in the downward trend of consumer prices, with inflation reaching 3.7% in August after 3.2% in July. This was significantly more than economists had expected. Although the core rate closely watched by the central bank, which is adjusted for the volatile prices of food and energy, fell as expected to 4.3% from 4.7% in July, experts do not yet see any end to the policy of raising interest rates. While futures markets are assuming that the Federal Open Market Committee will pause for breath this month, they have priced in the probability of a further, possibly final hike in interest rates by the Fed at its December meeting at 40%. This compares with just 33% a month ago. In Switzerland the peak in interest rates is likewise not yet a foregone conclusion, even if inflation has recently already fallen below the 2% mark. Some economists reckon that price rises will be moving back above the SNB’s target range of 0% to 2% towards the end of the year. The currency watchdogs must continue to be on their guard, then.
The high level of interest rates is playing into the hands of banks. As the latest reporting season shows, many institutions have revealed growing interest income, with Italian big bank UniCredit even upping its forecast on the back of the higher interest rates. The interest margin, which is the gap between the interest rate that the bank demands from borrowers and the rate it pays on deposits, is also continuing to widen. According to DWS, net interest income in the third quarter is heading for growth of 2.4% on the previous quarter. This is primarily due to the interest margin, which has widened by a massive 36% year on year. This trend is not such good news for ordinary bank customers, however, as it means that the more restrictive monetary policy of the central banks is tending to have less and less impact on savers. Investors should be aware, though, that there are lucrative alternatives to overnight money and the like.
Graph: Monthly inflation rate vs. Swiss base rate
