Expectations for large-scale policy easing in 2024 fall short, global central banks readjusting the path to interest rate cuts

The Smart Finance APP noticed that six months ago, major central banks around the world were preparing to implement a significant policy, which is undoubtedly good news for people with credit cards, planning to buy a house, or running a business: the global interest rate cut will lower borrowing costs and make loans easier to obtain.

Federal Reserve Chairman Powell pointed out at a press conference in December last year that rate cuts have become a "global topic and an issue we are discussing." At that time, investors were very excited about the possibility of a more accommodative financial environment. However, institutions such as the International Monetary Fund (IMF) expressed concerns about Powell and his team possibly taking rate-cut measures too early, fearing that this would weaken efforts to control inflation.

As it turned out, these concerns were unnecessary.

As major central banks face more persistent inflation than expected, and economic and wage growth show greater resilience, the joint easing monetary policy originally expected to be implemented by the end of 2023 does not seem to have the desired effect.

Nevertheless, some moderate measures have been taken, including the initial rate cuts by the European Central Bank and the Bank of Canada this month. However, these measures are mainly to fulfill commitments made when inflation seemed to be rapidly falling. From Europe and the UK to the US, central banks' sentiment has shifted from "starting rate cuts" to a more "patient waiting" attitude.

At a press conference last week, Powell emphasized that after rapidly raising rates in 2022 and 2023 to combat inflation, the initial easing actions will be "critical." The latest forecasts from Federal Reserve policymakers show that they only expect to cut rates by 25 basis points by the end of this year, a significant reduction from the three rate cuts forecasted in December last year and March this year.

Powell further stated, "When we really start to ease policy, it will be significantly accommodative in financial market conditions." He added, "We want to get things right."

The Bumpy Rate-Cut Journey

Most surveyed economists now expect the Federal Reserve to cut rates only once or twice this year, instead of the four times expected in December last year, when Powell unexpectedly hinted at a relatively quick shift to lower rate policies. However, economists' views are more consistent compared to market pricing.

Six months ago, economists expected the Bank of England to wait until the third quarter to lower borrowing costs, which is in line with the almost unanimous current expectation of action in August. Meanwhile, market pricing in December last year implied that the first rate cut would be in May, followed by three more rate cuts within a year.

Although overall inflation has dropped to near the Bank of England's 2% target, inflation in key service sectors in April was much higher than expected, and the 6% annual wage growth in May was still about twice the target level.

Therefore, it is expected that the Bank of England will keep rates unchanged at the last policy meeting of Prime Minister Sunak's term, meaning that measures to lower borrowing costs will wait for the next government in the UK Economists' predictions about the European Central Bank's first move have been confirmed, correctly predicting the rate cut in June. However, market prices have undergone significant changes: in December last year, market pricing implied a 140 basis point rate cut starting in March for a year. Now, market prices almost only correspond to a further rate cut this year.

Nevertheless, ECB policymakers had long warned that there would be "bumps along the way" as they bring inflation back to target, and by indicating in advance that the first rate cut would not come until June, they suggested that the market may be too forward-looking.

These "bumps" may now include market unease over French President Macron's decision to hold rapid parliamentary elections next month, which could bring an extreme right-wing government to power in Paris.

However, ECB President Lagarde and her team still generally believe that inflation will fall to the 2% target by the end of 2025.

"Central banks are managing the balance between inflation and economic growth," said Mario Centeno, Governor of the Bank of Portugal and ECB policymaker, in an interview, acknowledging that overly restrictive policies could disrupt the fragile recovery of the eurozone economy.

He said, "Ultimately, the difference between now and a few months ago is not significant. The story of inflation going down remains intact."

No central bank has declared victory

As always, managing expectations is part of the story.

Going back to December last year, when the expectation of three rate cuts in 2024 first appeared in the forecasts of Fed policymakers, Powell reminded at a press conference after the meeting, "No one is declaring victory over inflation." But the overall tone of his remarks - mentioning "real" and "significant" progress in inflation - seems to have solidified the market's view that rate cuts are imminent.

On the one hand, although the first rate cut may be as "significant" as Powell said last week, symbolizing the beginning of continued decline in borrowing costs, the exact timing may not be as important in terms of macroeconomic effects.

The strict wording on rate cuts, at least from Powell, may be more about managing expectations than actual prospects - keeping the door open to keeping rates at current levels for longer than expected.

Data around the Fed meeting last week strongly pointed to easing inflation pressures, with investors largely ignoring Powell's comments and new forecasts from Fed policymakers, sticking to the bet that rates will start to fall from September.

Nevertheless, the decline has been significant, and major central banks now allow "restrictive" monetary policy to pressure banks, businesses, and households for longer than expected. Some are concerned that this could trigger a tipping point.

Nick Bunker, Director of North American Economic Research at Indeed Hiring Lab, wrote in response to the Fed's decision last week, "Continued restrictive policies could overly depress labor demand and push the unemployment rate above the current 4%, while the Fed expects the unemployment rate to reach this level by the end of the year," "The labor market has seemed invincible for much of the past two years, but its armor cannot last forever." ”