Fed eyes steep rate hike as inflation soars

Fears of a US recession are spooking stock markets around the world as the Federal Reserve mulls its highest interest rate hike in 28 years.

The US central bank is considering upping the cost of borrowing by 0.75 percentage points in a bid to keep a lid on inflation which is running red-hot at 8.6 per cent.

The prospect of a hawkish Fed putting a dampener on growth has hammered the S&P500, which recovered slightly today after falling 3.9 per cent on Monday. The index closed 20 per cent down from its most recent high in January, putting it in bear market territory.

Nine of the last 12 US bear markets since 1948 have been accompanied by recessions. Morgan Stanley’s CEO, James Gorman, puts the probability of two quarters of negative growth this year at 50 per cent, although he did not expect any downturn to last for long.

The US isn’t alone in being forced into a corner by rising prices and faltering growth. Policymakers from Sweden to Singapore face variations of the same dilemma: the higher interest rates needed to tame inflation threaten growth by driving up borrowing costs for consumers and businesses.

In the Eurozone, bond yields are rising, particularly on Italian and Greek debt. While growth remains sluggish, the European Central Bank’s Christine Lagarde has confirmed speculation that rates will rise after a decade of rock-bottom and even negative borrowing costs.

The complicating factor in the Eurozone is that the ECB has been propping up indebted countries which can’t deflate their currencies to weather economic storms. If the Bank raises rates too quickly it could prompt a market panic and risk a replay of the Eurozone debt crisis of the 2010s.  

In the UK, a week of woeful economic data has highlighted the bind the Bank of England finds itself in.

UK growth unexpectedly fell in April and is set to flatline next year. But with inflation set to average 8.9 per cent in the second quarter, economists now predict the cost of borrowing will hit 2 per cent by this time next year, according to a survey by Bloomberg. Financial markets are even more hawkish, pricing in interest rates of above 3 per cent next year.

The £15bn cost-of-living package, a tight labour market, and fuel prices at all-time highs will put more upward pressure on prices. The Bank’s Monetary Policy Committee is expected to vote in favour of a 0.25 percentage point rise to 1.25 per cent on Thursday.

The story is slightly different in China, which has inflation largely under control. Its central bank might even cut rates this week. In a country still plagued by a plague – Covid – and its over-zealous response to it, consumer confidence and its impact on growth are bigger worries. China’s GDP is set to grow by just 2 per cent this year, a snail’s pace by historic standards.

It’s a worrying global backdrop to the Fed’s decision, which is due tomorrow.