The central banks of the US and the UK may raise interest rates by 75 basis points this week, with differing motivations behind the move.

This week, the Federal Reserve and the Bank of England will hold a highly anticipated monetary policy meeting, with the market widely expecting both central banks to announce a 75 basis point rate hike. However, despite the same magnitude of the rate increase, the considerations of the two central banks are quite different.

For the Federal Reserve, this will be the fourth consecutive large interest rate hike of 75 basis points. The Federal Reserve is at a critical crossroads: on one hand, the post-pandemic economic recovery momentum is weakening; on the other hand, inflation remains at its highest level in 40 years. The Federal Reserve needs to make a tough choice between curbing inflation and avoiding an economic recession. The market expects the Federal Reserve to be more inclined towards the latter.

In contrast, the Bank of England's decision to raise interest rates by 75 basis points will set the largest single rate hike since 1989. Under the dual pressures of high inflation and economic recession, the Bank of England seems more inclined to prioritize tackling inflation. With the political turmoil temporarily subsided, the Bank of England can now focus on addressing the most severe inflation issue in 40 years.

The Federal Reserve may slow its pace after raising interest rates

Last week, the U.S. bond market warmed up, and the yield on 10-year Treasury bonds dropped to around 4%. Some investors believe that the Federal Reserve's previous tightening policy may have caused negative impacts on the economy, and therefore, it may slow down the pace of interest rate hikes in the future.

This view has received support from some Federal Reserve officials. The President of the San Francisco Fed, Daly, who will have FOMC voting rights in 2024, stated that the Federal Reserve should avoid aggressive rate hikes that could lead to an economic recession and that it should start discussing slowing down the pace of rate increases. Chicago Fed President Evans also warned that if next year's peak interest rates far exceed expectations, the economy will face significant risks.

However, inflationary pressures in the United States remain enormous. The core PCE price index accelerated for two consecutive months in September, and consumer inflation expectations also rose in October. This means that the Federal Reserve still has a long way to go in combating inflation.

The market has largely digested the expectation of a 75 basis point rate hike in November, but there are still differences regarding the extent of the rate hike in December. Some analysts believe that the Federal Reserve may continue to raise rates significantly in December unless inflation data improves significantly.

At the same time, the market's expectations for the Federal Reserve to gradually slow down its interest rate hikes are heating up. The yield on 10-year Treasury bonds fell sharply last week, reflecting this expectation. Investors expect economic growth to slow significantly, and the Federal Reserve may start cutting interest rates next year. As a result, investors are increasing their holdings of long-term Treasury bonds, with multiple surveys showing that net long positions in Treasury bonds have rebounded to recent highs.

The Bank of England may implement the largest single interest rate hike in 33 years.

The Bank of England's interest rate meeting this week faces a more complex situation. Due to the new government's delay in announcing its fiscal plans, the Bank of England will make decisions without understanding the fiscal details.

The market generally expects that the Bank of England may announce an interest rate hike of 75 basis points, the largest single rate increase since 1989. Compared to the Federal Reserve, the situation for the Bank of England is more challenging.

First, the inflation problem in the UK is more severe. In September, the inflation rate reached 10%, returning to a 40-year high. The Bank of England has previously warned that a more significant rate hike may be needed to address the soaring cost of living. The new Prime Minister Sunak has also stated that tackling inflation is a current policy priority.

Secondly, the risk of economic recession in the UK is greater. The Bank of England expects the economy to fall into recession in the fourth quarter of this year and to continue until the end of 2023. Some analysts even believe that the recession may extend into 2024.

In addition, the Bank of England's pace in this round of interest rate hikes lags behind that of the Federal Reserve and the European Central Bank, making its situation even more awkward. After the Federal Reserve raised rates by 75 basis points three consecutive times and the European Central Bank also raised rates by 75 basis points in one go, the Bank of England's rate hikes seem comparatively modest.

With the political situation temporarily stabilizing, the UK bond market has recently shown signs of recovery, rising significantly for two consecutive weeks. This provides some leeway for the Bank of England to take more aggressive actions. However, achieving a balance between curbing inflation and avoiding an economic recession will still be a huge challenge for the Bank of England.