• The cycle of rising interest rates looks to be winding down globally.
• We think that interest rates are close to peaking, or have already peaked, in the UK and the euro area, but further hikes are likely in the US.
• We don’t think investors should expect interest rates to come down until the second half of 2024.

Interest-rate pauses by the Federal Reserve, the US central bank, and the Bank of England last week reflect their progress in the fight against inflation. Rate-hiking cycles are winding down globally.

The Federal Reserve (Fed) held its target for the federal funds rate in a range of 5.25%–5.5% on 20 September. This was followed by the Bank of England’s (BoE’s) decision to hold its bank rate at 5.25% on 21 September. This ended 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 interest 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 interest rate by a quarter percentage point to 4% on 14 September.)

However, we believe that one to three more quarter-point hikes may be required by the Fed to achieve its 2% target, with the US central bank predicting core inflation won’t come down to that level until 2026.

UK inflation beginning to cool

UK inflation data released on 20 September likely influenced BoE policymakers, who were debating whether to maintain the bank rate or raise it by a quarter percentage point. The rate of inflation (both headline and core) in the UK remains above 6% and far above the BoE’s 2% target.

Core inflation (which excludes alcohol, tobacco, food and energy prices) slowed sharply in August, led by services, but wage growth remained elevated 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.

Why further rate hikes may be needed in the US

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 rate increases or by keeping rates higher for longer. Alongside its 20 September decision to hold rates, the Fed projected that interest rates in 2024 and 2025 are likely to be half a percentage point higher than they had projected in June.

What should investors expect

While rates may have peaked or are close to peaking, we don’t think investors should expect central banks to start cutting rates immediately.

Once peak rates are reached, they are likely to stay there for an extended period. 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 markets, which seem to anticipate rate cuts starting in early 2024. 

One factor behind this view is that the neutral rate of interest—a theoretical rate that neither promotes nor restricts economic activity—is higher than many may imagine.