The Federal Reserve (Fed) held its target for the federal funds rate in a range of 5.25%–5.5% on 20 September, followed by the Bank of England’s (BoE) decision to hold its bank rate at 5.25% on 21 September – ending a series of 14 successive rate hikes in the UK since December 2021.
Both central banks emphasised the need to remain vigilant to return inflation to their 2% targets.
Vanguard believes that one to three more quarter-point hikes may be required by the Fed to achieve its 2% goal, with the US central bank predicting core inflation won’t come down to target until 2026. We believe that policy rates are close to peaking, or already have peaked, in the UK and the euro area.
Economic activity has slowed notably in both places. (The European Central Bank raised its policy interest rate by a quarter percentage point to 4% on 14 September.)
UK inflation data released on 20 September likely influenced UK policymakers, who were debating whether to maintain the bank rate or raise it by a quarter percentage point. Both headline and core inflation in the UK remain above 6% and far above the BoE’s 2% target.
Pressures on core inflation (which excludes alcohol, tobacco, food and energy prices) eased sharply in August, led by services, but wage growth remained elevated—the annualised rate was more than 8% in the private sector for the three months ending 31 July—and rising oil prices represent another risk. If wage growth and energy prices remain strong, we see a risk that the UK’s bank rate may need to go higher still.
"Once the terminal rates are reached, they’re likely to stay there for an extended period."
Senior Economist, Vanguard, Investment Strategy Group
In the US, inflation has moderated faster than in the UK, although core inflation, which excludes volatile food and energy prices, above 4% is still more than double the Fed’s target.
We think US inflation numbers are moving in the right direction, allowing the Fed to take more of a wait-and-see approach. At the same time, we believe a resilient economy—particularly a resilient services sector—keeps the potential for further rate hikes on the horizon.
For the Fed to really succeed in reining in inflation, we think more is needed - whether through further marginal increases in rates or by keeping rates higher for longer. Along with its 20 September decision to hold rates, the Fed projected that its interest-rate targets in 2024 and 2025 are likely to be half a percentage point higher than it had projected in June.
While rates may have peaked or are close to peak, we don’t think investors should expect central banks to start cutting rates immediately.
Once interest rates reach terminal levels, they’re likely to stay there for an extended period and we’re not expecting to see rate cuts in either the US or UK until the second half of 2024.
This is where Vanguard’s view really differs from the market consensus, which seems to anticipate rate cuts starting in early 2024.
One factor behind our belief is that the neutral rate of interest—the theoretical rate that neither promotes nor restricts economic activity (also known as R-star)—is higher than many may imagine. We discussed this in detail during our last quarterly investment outlook webinar, which you can watch on demand.
The Fed, in its rate projections, kept its assessment of the neutral rate—the median of its long-run federal funds rate target projection—at 2.5%. Vanguard believes that the neutral rate for the US economy is closer to 3.5%, suggesting that a return to the low-rate environment of the recent past is unlikely any time soon.
Investment risk information
The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.
Past performance is not a reliable indicator of future results.
For professional investors only (as defined under the MiFID II Directive) investing for their own account (including management companies (fund of funds) and professional clients investing on behalf of their discretionary clients). In Switzerland for professional investors only. Not to be distributed to the public.
The information contained in this document is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information in this document does not constitute legal, tax, or investment advice. You must not, therefore, rely on the content of this document when making any investment decisions.
The information contained in this document is for educational purposes only and is not a recommendation or solicitation to buy or sell investments.
Issued in EEA by Vanguard Group (Ireland) Limited which is regulated in Ireland by the Central Bank of Ireland.
Issued in Switzerland by Vanguard Investments Switzerland GmbH.
Issued by Vanguard Asset Management, Limited which is authourised and regulated in the UK by the Financial Conduct Authority.
© 2023 Vanguard Group (Ireland) Limited. All rights reserved.
© 2023 Vanguard Investments Switzerland GmbH. All rights reserved.
© 2023 Vanguard Asset Management, Limited. All rights reserved.