EFGAM’s Hawkishness Indicator: hawks remain airborne

The Fed, ECB and BoE provide a window into their thinking though the release of meeting minutes. In this Macro Flash Note, Economist Sam Jochim provides an update on the perceived hawkishness of each central bank with the help of EFGAM’s Hawkishness Indicator. 

The EFGAM Hawkishness Indicator (EHI) seeks to gauge the policy bias at central bank meetings by counting the number of times key words such as “elevated”, “robust”, “high”, and “strong” are repeated in the published meeting minutes. The output sums the number of times each key term appears.

The Federal Reserve (Fed) has been characterised in 2024 by a hawkish shift, reflecting slower progress in its inflation battle. At the start of the year, markets were expecting six rate cuts in 2024, with the first having been anticipated in March. Entering the second half of the year, the Fed has not yet reduced interest rates and markets now expect just two rate cuts before year-end.

Unsurprisingly, the shift in market expectations coincided with a shift in the perceived hawkishness of the Fed (see Chart 1). The EHI fluctuates from meeting-to-meeting and so it is more informative to observe its broader trends, which show a stabilisation in Fed hawkishness since early 2023. The Indicator has a 69% correlation with year-on-year core personal consumption expenditure (PCE) inflation and so the fact that disinflation progress since 2022 led to a meaningful decline in hawkish rhetoric from the US central bank is unsurprising.¹

Chart 1. EFGAM Fed Hawkishness Indicator²

Source: Federal Reserve, LSEG Data & Analytics and EFGAM calculations. Data as at 4 July 2024.

Nonetheless, the EHI for the Fed was at 51 in June and remains above its long-term median level of 44.5, highlighting an important point.³ It is likely that the next interest rate move in the US is lower, but until the Fed has gained more confidence that inflation is headed sustainably to its 2% target, it has little incentive to adopt a meaningfully more dovish rhetoric.

The Bank of England (BoE) has become more hawkish in 2024 according to the EHI (see Chart 2). Despite headline inflation falling to its 2% target in May, core inflation remains above target and services inflation, a key area of focus for the Bank, has proved stickier than it expected.⁴

Chart 2. EFGAM BoE Hawkishness Indicator

Source: Bank of England, LSEG Data & Analytics and EFGAM calculations. Data as at 4 July 2024.

In June, the EHI for the BoE rose from 22 to 40, above its long-term median level of 21.⁵ The indicator’s correlation with core CPI inflation is lower than for the Fed, at 45%, possibly indicating the difficulty the Bank has in clearly communicating its thinking.⁶

Yet the BoE is in a similar position to the Fed. The next interest rate move in the UK is likely to be lower, but until the Bank has gained more confidence that inflation is headed to its 2% target in a sustainable manner, with services inflation also easing, it too has little incentive to adopt a meaningfully more dovish rhetoric.

The European Central Bank (ECB) is an outlier in that it has reduced interest rates in 2024, doing so by 25 basis points in June. Somewhat surprisingly though, the EHI for the ECB rose from 55 to 88 in June, remaining well above its long-term median of 35.5 (see Chart 3).⁷

Chart 3. EFGAM ECB Hawkishness Indicator

Source: European Central Bank, LSEG Data & Analytics and EFGAM calculations. Data as at 4 July 2024.

One possible explanation is that the increase in the EHI reflects the recent stalled disinflation progress. The EHI for the ECB has an 85% correlation with eurozone core inflation, which rose between April and June.⁸

It could also highlight the difference in views within the Governing Council. The latest ECB minutes noted that “some members felt that the data available since the last meeting had not increased their confidence that inflation would converge to the 2% target by 2025 but instead pointed to greater uncertainty in the outlook”.⁹ Having already cut rates once, the ECB is likely to wait until it becomes more confident that inflation will return to the 2% target sustainably before cutting rates again.

In conclusion, there has been a meaningful decline in the EHIs for the Fed, ECB and BoE relative to their peaks in 2022. Nonetheless, all three remain above their long-term medians reflecting that the central banks have little to gain from adopting a more dovish rhetoric before they have gained more confidence that inflation is sustainably returning to 2%.

¹ Fed EHI and core PCE inflation correlation measured on data from January 2010 to May 2024.
² Fed funds rate shows the upper bound of the Fed funds target range.
³ Fed EHI long-term median calculated on data from January 2010 to June 2024. It should be noted that most of the pre-pandemic sample reflected a period in which the Fed faced below-target inflation and so had little incentive to adopt a hawkish rhetoric. This lowers the long-term median.
⁴ In its May Monetary Policy Report, the Bank of England forecast services inflation of 5.3% year-on-year in May. Actual services inflation was 5.7% year-on-year in May.
⁵ BoE EHI long-term median calculated on data from January 2010 to June 2024.
⁶ BoE EHI and core CPI inflation correlation measured on data from January 2010 to May 2024.
⁷ ECB EHI long-term median calculated on data from January 2015 to June 2024.
⁸ ECB EHI and core HICP inflation correlation measured on data from January 2015 to June 2024.
⁹ https://go.pardot.com/e/931253/ecb-mg240704fbde4f46aa-en-html/48xvg/392205193/h/y8jCBBu5v2_Iy96_qMu_Q6XKb8rfuhgVAG68bEAonrk