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Fed set to hike while ECB remains cautious

By Tim Stewart
3 minute read

The US Federal Reserve is expected to increase its target interest rate by 25 basis points today, while the European Central Bank will continue its cautious approach to winding back stimulus, says Fidelity International.

US Federal Reserve chair Jerome Powell will hold a press conference later today during which it is expected he will announce a 25 basis points hike to the federal funds rate.

According to Fidelity International investment director Andrea Iannelli, the Federal Open Market Committee (FOMC) is likely to go ahead with the hike given strong US growth, solid employment numbers and inflation "not too far from target".

"Beyond the decision itself, investors will scrutinise any change in the Fed’s forecasts and in the 'dot plot', looking for signs that a faster hiking cycle lies ahead," Mr Iannelli said.

According to market pricing, it is a "given" that the Fed will hike later today, he said – and one more is priced in by the end of 2018.

"There is a risk of a hawkish surprise and the Fed hinting perhaps at two more rate hikes to come by December," Mr Iannelli said.

"Such an outcome, however, risks fuelling yet another round of USD strength and risk aversion, with risky assets that have grown more sensitive to higher US rates and higher funding costs.

"The Fed is obviously driven primarily by the domestic economy but they can’t ignore the impact they have on global financial conditions, and have worked hard to guide market expectations to where we are now. It is unlikely that they will want to rock the boat," he said.

It is a different story for the European Central Bank, which meets on Thursday and is still actively engaged in quantitative easing (meaning a rate hike is a long way off).

"The June meeting is now 'live' after last week’s comments from Peter Praet, the ECB’s Chief Economist, who sounded confident on the European recovery and that some removal of stimulus is warranted," Mr Iannelli said.

The ECB's EU program is "widely expected" to end this year, he said.

"Macro data in Europe has disappointed of late, with both hard and soft data on a downward trend. On the inflation front, the high print recorded in May, when Eurozone CPI hit 1.9 per cent, gives the Governing Council enough momentum to reduce QE purchases but it’s likely to be only a temporary spike and should partially retrace by year-end.

"Core inflationary pressures, meanwhile, are still subdued. Against this backdrop, even though QE may be coming to an end, the ECB will keep a cautious tone in the months ahead.

"This sets it in contrast to the Fed and the two central banks will remain on diverging policy paths," Mr Iannelli said.