The world’s financial markets are preparing for the sharpest rise in US interest rates in almost 30 years, as America’s central bank took action to halt rising inflation.
After days of frenzied investor speculation and signs of growing central bank anxiety, the Federal Reserve is expected to increase the official cost of borrowing by 0.75 percentage points for the first time since 1994.
The Fed meeting, with an interest rate announcement due at 7pm UK time on Wednesday, was preceded by an emergency meeting of the European Central Bank (ECB) to discuss crashing bond prices in Italy, Spain, Portugal and Greece.
After disappointing markets by its failure to act at a scheduled meeting last week, the ECB council said it would take two steps to prevent the fragmentation of the eurozone.
The Frankfurt-based central bank said it was developing a new support tool and would also direct cash from debt maturing in a recently ended €1.7tn pandemic support scheme towards vulnerable eurozone countries.
“The pandemic has left lasting vulnerabilities in the euro area economy which are indeed contributing to the uneven transmission of the normalisation of our monetary policy across jurisdictions,” the ECB said in a statement.
The Bank of England is expected to raise UK interest rates on Thursday, after the rise in UK inflation to a 40-year high. Despite some speculation of a 0.5 point increase, the City expects a 0.25 point rise to 1.25%.
The Fed’s chairman, Jerome Powell, had previously ruled out a 0.75 point increase but the central bank appears to have had a change of heart after higher than expected US inflation was announced last week.
News that the US measure of the cost of living had hit 8.6% – the highest in four decades – prompted a sharp sell-off in bonds and share prices, as investors took fright at the possibility of action to combat high inflation leading to recession.
The S&P 500 index – a broad measure of the health of the US stock market – has fallen 20% since its peak in January, while the technology-rich Nasdaq index has dropped by a third.
“Investors have now fully aligned with the view that the Fed will hike by 0.75 points today, following the unexpected acceleration in inflation and inflation expectations in May and media reports suggesting the option was being discussed by policymakers,” said analysts at ING bank.
“While a 75 basis-point move is not certain, we doubt such potential ‘leaks’ to the media are a coincidence, and they do appear to us as a (successful) attempt to adjust expectations during the blackout period and prepare markets for the larger increase.”
The prospect of a bigger than expected jump in US interest rates coupled with weak growth figures in the UK pushed the pound to its lowest level in two years against the US dollar.
Neil Wilson, an analyst at Markets.com, said of the ECB move: “Given there was a scheduled meeting last week, it smacks of panic and a lack of control, but the market is happy to see it happen. European bank shares rose and the euro also rallied, while Italian yields came back down.”
Andrew Kenningham, the chief Europe economist at Capital Economics, said: “News that the ECB governing council is holding an emergency meeting today shows that policymakers are taking the threat of rising peripheral yields more seriously than they were last Thursday at their regular policy meeting.”
The Fed statement and remarks by Powell at a press conference immediately afterwards will be scrutinised to see whether further sharp increases in US rates are likely. Some analysts think the central bank will raise them by 0.75 points again next month.