The U.S. Federal Reserve, European Central Bank and Bank of England on Tuesday all dampened expectations for aggressive interest rate rises to counter rising inflation, sending global stocks and bonds surging in relief.
The initial salvo came from senior Fed officials who separately told two international newspapers that the U.S. central bank was unlikely to raise interest rates in the next few months unless the inflation outlook worsens.
The reports, carried in Tuesday's editions of the Financial Times and Wall Street Journal, both cited "Fed officials" and said financial market speculation that the Fed could hike rates several times this year is probably overdone.
"They (senior Fed officials) do not dispute that the next move in U.S. interest rates is very likely to be up. But they feel the market may be pricing in too much tightening too soon," the FT said.
The Journal story said the Fed's policy-making Open Market Committee meeting next week was "unlikely to go so far as to ratify market expectations of a rate hike as soon as August."
With financial markets betting as recently as Monday on a quarter-point increase in the Fed's key target rate of two percent by August and another by October, the comments helped lift world stocks, drag down U.S. Treasury yields and weaken the dollar.
EUROPEAN DOVES WEIGH IN
But dollar losses were limited as senior European Central Bank officials delivered similarly dovish comments on the outlook for their interest rates.
Executive Board member Lorenzo Bini Smaghi was quoted as saying that a quarter percentage point rise in the ECB's main interest rate should be enough to bring euro zone inflation back below 2 percent.
"In our view such a tightening, which I would call significant even if (it is) just 25 basis points, should be able to bring inflation back below the 2 percent target in the next 18-24 months," he said in an interview with Italian daily Il Sole 24 Ore published on Tuesday.
After shocking European interest rate markets earlier this month with a warning of a rise in its key policy rate in July, financial markets had moved to discount a quarter-point rise to 4.25 percent next month and another later in the year.
Bini Smaghi's comments, however, saw a decline in European government bond yields and expected short-term interest rates by year end and sent the euro back lower against the dollar.
Economists said the switch of tone underlined the macroeconomic policy dilemma facing central banks as they cope with conflicting signals from rising inflation and slowing economic growth.
"They're looking through the peak in inflation, but every time they look the peak is a little bit higher," Geoffrey Dicks, economist at RBS in London. "So far at least, they seem to be living with this level of discomfort without acting."
ECB governing council member and Bank of Spain chief Miguel Angel Fernandez Ordonez said in speech later that central bank were facing a complex situation and the ECB would continue to "analyze events with maximum attention."
BANK LETTER
Yet rate rise expectations were further depressed by the Bank of England later on Tuesday even after reports of UK inflation rising to 3.3 percent in May — above forecasts and more than a percentage point above the bank's two-percent inflation target.
In a letter to the government explaining the overshoot, the UK central bank said that while inflation could yet spike above 4 percent this year on soaring food and fuel bills, the focus was on bringing inflation back to the 2 percent target in two years' time.
Bank governor Mervyn King wrote: "On the downside, the risk is that the slowdown could be so sharp that inflation did not just return to the target but was pulled below."
King added that the bank's Monetary Policy Committee believes that if key rates were set to bring inflation back to target within 12 months "the result would be unnecessary volatility in output and employment."
Money markets, which had been betting on as many as three interest rate rises from the current 5.0 percent, moved swiftly to price in a lower rate trajectory with implied sterling interest rate falling on the statement.
"The BoE believes that inflation will peak later this year and then fall back towards target and they seem at pains to suggest that an aggressive series of rate hikes, as currently priced in by markets, is unlikely," said James Knightly, economist at ING in London.
