Six months ago, the world’s major central banks were preparing for a move that would reward anyone with a credit card or hoping to buy a home or run a business: A global shift to lower interest rates that would make borrowing cheaper and loans more available.
Interest rate cuts are “a topic of discussion in the world and also a topic of discussion for us,” Federal Reserve Chairman Jerome Powell said at a press conference last December, when the mood among investors was focused on the prospect of looser economic conditions, despite that organizations such as the International Monetary Fund were concerned that Powell and other Central Bankers would cut interest rates too quickly and undermine efforts to tame inflation.
Those fears were misplaced, it turned out
The concerted easing of monetary policy that seemed imminent in late 2023 has largely been “frozen” as major central banks grappled with inflation proving more stubborn than expected and economic growth and wage growth more resilient.
Some modest steps have been taken, including initial cuts this month by the European Central Bank and the Bank of Canada. But that was largely to fulfill a promise made when inflation appeared to be falling fast and the mood in Frankfurt, London, Washington and elsewhere has since shifted away from the central bank’s version of “start your engines”. to something more akin to “hold your horses”.
After raising rates rapidly in 2022 and 2023 to fight inflation, the initial move to ease policy will be “consequential,” Powell told a news conference last week when new forecasts from policymakers The Fed indicated they expect only a quarter of a percentage point cut in interest rates by the end of the year, down from the three expected in December and March.
“When we start to ease policy, that will be seen in significant easing and financial market conditions,” Powell said.
Obstacles on the way
Most economists now expect just one or two Fed rate cuts this year instead of the four seen in a survey last December, before Powell surprised markets by suggesting a relatively short shift to lower rates. But economists were more consistent in their views than in market prices.
Economists polled had expected the Bank of England to wait until the third quarter to cut borrowing costs, in line with current near-unanimous expectations for a move in August. December’s market pricing, meanwhile, involved a first cut in May, followed by three more over the course of the year.
While inflation has eased close to the BoE’s 2% target, it was much higher than expected in the core services sector in April and annual wage growth of 6% in May remained almost twice the level consistent with the target.
Accordingly, the BoE is expected to keep interest rates on hold at its next policy meeting under Prime Minister Rishi Sunak – meaning the move to lower borrowing costs will await Britain’s next government.
Economists’ predictions for the ECB’s first move were also correct, correctly predicting a cut in June. But again, market pricing has shifted dramatically: in December it implied cuts of 140 basis points next year, starting in March.
Now the market is barely pricing in another rate cut this year. ECB policymakers, however, have long warned of “proportionate moves” as they bring inflation back to target and – saying early on that the first cut would not come until June – signaled that markets may have overdone it.
Those “bumps” may now include how markets have been rattled by French President Emmanuel Macron’s decision to hold early parliamentary elections that could lead to a far-right government in Paris next month. However, for now, ECB President Christine Lagarde and her team remain broadly confident that inflation will continue to fall below the 2% target until the end of 2025.
No declaration of victory
As always, managing expectations is part of the story.
In December, when the prospect of three cuts to 2024 first appeared in the Fed’s policy projections, Powell warned at the post-meeting news conference that “no one is declaring victory” on inflation.
But the broad sweep of his remarks – with references to “real” and “substantial” progress being made on inflation – appeared to have cemented views that rate cuts were about to begin.
In one sense, while the first cut, as Powell said last week, may be “subsequent,” the symbolic opening of an expected steady reduction in borrowing costs, the exact timing may be shorter in terms of its macroeconomic impact.
The current tight language on cuts, at least from Powell, may be more about managing expectations than the actual prospect – keeping the door open for rates to stay where they are again longer than expected.
Data just before and after the Fed’s meeting last week strongly suggested weakening price pressures, and investors have largely shrugged off Powell’s comments and new forecasts from Fed policymakers to hedge bets that interest rates will be reduced from September. But the slide has been wide, with major central banks now allowing “tight” monetary policy to weigh on banks, businesses and households for months longer than expected.
Some worry that they might trigger a tipping point.
