Leading indicators: Are we at the peak of the interest rate cycle?

While central bank efforts to combat inflation appear to be paying off, Simon Rubinsohn, RICS Chief Economist, cautions relief in real estate markets globally might not be felt until well into 2024.

Combatting inflation spikes

The single-minded focus of the world’s major central banks on combatting the spike in inflation appears, on the face of it, to be paying dividends. Recent figures suggest the global headline rate has more than halved from its peak of over 11.5% in the second quarter of 2022 to around 5%. Moreover, there has been further progress in the US, with the October inflation rate coming in at just 3.2%.

Critically, several other indicators that typically capture emerging cost pressures are telling a similar story. For example, despite conflict in the Middle East, oil prices have been falling over recently. Brent crude currently trading at around $80 per barrel compared with a September high approaching the $100 mark. Alongside this, other commodity price indices, whether measuring metals or agriculture, have been trending downwards, to a greater or lesser extent, since the beginning of the year.

A resurgence in the pipeline?

Even so, it is evident that policymakers are not convinced the battle with inflation has been won just yet, and have been forthright in making this point. Most significantly, US Federal Reserve Chair, Jerome Powell, recently warned against the risk of being ‘misled’ by some good data on prices. Christine Lagarde at the ECB has also suggested that ‘there will be a resurgence of probably higher [inflation] numbers going forwards’. Andrew Bailey at the Bank of England has taken a largely parallel approach, pointing to the ‘upside risks’ to inflation.

Whether this messaging is designed to discourage markets from getting ahead of themselves or justified by underlying fundamentals, remains to be seen. That said, it is worth bearing in mind that most independent forecasters are anticipating further progress in reducing inflation rates over the next 12 months rather than a renewed upsurge in price pressures. And that seems a more likely outcome to me.

For now, money markets seem to be largely taking direction from the policymakers. Even if the communication from central banks is that we are at the peak of the interest rate cycle, there is no rush to assume monetary policy will be eased anytime soon. Put another way, the markets appear to be taking at face value the ‘higher for longer’ mantra that the US Federal Reserve (the Fed), in particular, has been espousing.

However, in a warning that nothing should be taken for granted, the Reserve Bank of Australia (RBA) recently decided that there was still a justification for adopting a more restrictive policy stance. Significantly, it lifted its key cash rate target by a further quarter point after leaving it on hold for four successive meetings, citing that inflation was still ‘too high’.

Core inflation could prove resilient

Underlying this move by the RBA is the more generally held view among central bankers that inflation is still at a level that could become embedded in the expectations of households and businesses. And that as a result, even if the headline inflation rate were to continue to drift lower, core inflation could prove considerably more resilient. This possibility is fuelling understandable concern about how much more challenging it could ultimately prove to get inflation back to target as well as the potentially greater damage to the economy in the trying to achieve this goal. This helps to explain Jerome Powell’s warning not to bet against the Fed also taking similar action (to the RBA) over the months to come.

To be fair, judging what is sufficient in terms of interest rate management is never easy, particularly when approaching turning points in an economic/inflation cycle. There are clear and understandable limitations in the ability of central banks to precisely calibrate their strategies. Variable lags in the way that past policy measures feed through into key macro metrics create complications, as does the inevitable uncertainty regarding the neutral level of interest rates at any point in time.

Real estate market sentiment remains negative

So, just as there is a risk that policy may still be undercooked to ensure a sustainable return of inflation to set targets over the medium term, there is also a danger that a delayed response from central banks could result in a costly slowdown in economic activity just as the global economy appears to have avoided recession. Mary Daly, president of the Federal Reserve Bank of San Francisco, put it differently in a recent interview with The Financial Times when she acknowledged that ‘we have to be bold enough to say we don’t know and bold enough to say we need to take the time to do it right’.

Meanwhile, the tighter monetary stance around the world, is having an impact on real estate, a point once again highlighted in the Q3 RICS Global Commercial Property Monitor (released at the end of October). The Commercial Property Sentiment Index racked up its sixth consecutive negative quarterly read. Meanwhile, the similarly aggregated Construction Activity Index, which forms part of the RICS Global Construction Monitor, while still in positive territory, is less so than in previous iterations of the survey.

In both cases, there are, needless to say, strong country and sector skews, but it is clear that despite a measure of resilience in some areas, the burden of higher interest rates is increasingly being felt on the overarching picture. My suspicion is that it will, nevertheless, be the middle of next year before any relief is likely to be forthcoming.