The American Federal Reserve and the European Central Bank have started together, although with differences, a process of lowering rates which should last several quarters. The two central banks have the same objective, to ensure that inflation stabilizes around 2%, and both have committed in recent months to pursuing a “data-dependent” policy, without anticipating future movements, in order to be able to evolve flexibly and not be tied to a specific roadmap. These data, however, are starting to point in different directions on both sides of the Atlantic, and The possibility that the two central banks will have to take different paths in the coming months is taking on more and more weight. the pace at which interest rates are moderating in their jurisdiction.
The latest inflation data provides the best evidence of the differences between the macroeconomic situation of the United States and the Eurozone. Rising prices are showing signs of strength in the United States, and the latest employment data anticipates that the Fed will have to modify the planned roadmap and will not be able to cut rates as quickly as l are waiting for the markets and investors. .analysts. In Europe, on the other hand, the situation is the opposite: inflation fell below the central bank’s 2% target in September, confirming the fears of ECB members, who were already worried in November about having gone too far with the rate hike in 2022. and 2023.
The last to recognize the possibility that the ECB has gone too far in tightening monetary policy and must now respond with more aggressive rate cuts than expected was François Villeroy de Galhau, president of the Banque de France and member of the Governing Council of the ECB. For Villeroy, “the balance of risks is changing” for the central bank, and “if over the last two years our main risk was that inflation skyrocketed above 2%, now we must do be careful on the contrary, that we will We have not achieved our objective due to weak growth and a restrictive monetary policy which has lasted for too long.
This is not the first time the ECB has highlighted the possibility that rising rates in 2022 could end up pushing inflation below the 2% target. The minutes of the monetary policy meeting held by the central bank in October 2023 reflected for the first time these fears of the members of the body. “Although it is assumed that the last step to bring inflation down to 2% is the most complicated, the Governing Council must be very careful so that its efforts to smooth inflation growth do not bring it down below its objective. ” read the minutes of the meeting.
Inflation data separates ECB and Fed
The ECB and Federal Reserve have emphasized in recent months that their approach is currently “data dependent”. Everything will depend, meeting after meeting, on what the data indicates, and in this sense, it seems that the two central banks will be forced to take opposite paths. The main indicator monitored by central banks is inflation, which gives divergent signals in the United States and the Eurozone. This is the main argument why the Fed could be forced to slow down the rate reduction process, while the ECB will probably have to accelerate it.
In the euro zone, the rate of inflation has already fallen to 1.8% in September, for the first time in this cycle, below the ECB’s objective, which confirms the fears made public by members of the central bank in November. To begin with, markets assumed from this data that the ECB would cut rates again at next week’s meeting. “It looks like the ECB could say yes in October. September’s inflation figures confirm much of what we already suspected. The slowing economy is translating into disinflationary forces,” explains JP Morgan Private Banking . “Since their last meeting, ECB officials have expressed confidence in reducing inflation. It is beginning to appear that they are preparing for a faster pace of reductions than the quarterly pace announced so far,” underline the bank’s analysts. .
On the contrary, in the United States, inflation remains stubborn and refuses to moderate its growth. The latest data, from August, was 2.5%seven tenths above that of the euro zone, and above the objective maintained by the Federal Reserve. Analyst estimates for the data to be released this Thursday, corresponding to the month of September, point to a moderation in August, up to 2.3%, still above the Fed’s target. However, a surprise greater than expected could trigger a new delay. the rate cuts expected by the markets.
Not only does past inflation data indicate that prices are pushing the ECB to accelerate rate cuts, and the Fed to slow them down. Long-term inflation expectations, one of the indicators that central bankers monitor most when deciding the direction of their policies, are also moving in this direction. The inflation swap 5 years 5 yearswhich includes the evolution of prices expected by investors for the five years starting in five years, now indicates expected inflation of 2.5% in the United States for this period, compared to 2.1% in the euro zone.
Employment, the Fed’s last obstacle to lowering rates
There is a difference between the monetary policy of the Federal Reserve and that of the ECB, which now also indicates that the paths of the two central banks are diverging. The Fed’s mandate does not only include price stability: it is also responsible for ensuring that unemployment does not explode in the country, unlike the powers of the ECB, which do not include this responsibility . Indeed, the Fed warned in July that it would increasingly take into account employment as a guiding factor in its monetary policy, given the signs of deterioration shown by the country’s labor indicator.
However, the latest jobs data released in the United States, those of September, were the indicator that confirmed that the Fed must rethink the pace of rate cuts, as they reflected an improvement that analysts do not didn’t expect. “Better-than-expected US jobs data will likely dissuade the Fed from making a misstep and cutting interest rates by 50 basis points in November,” says David Kohl, chief economist at Julius Baer . “The likelihood of another 50 basis point cut at the November meeting has declined sharply.”and could only increase if the next employment data, which will be published just six days before the meeting, surprises negatively,” confirms Kohl.
Sergio Avila, senior market analyst at IG Markets, agrees. “The rebound in U.S. bond yields is because the jobs report reduces the urgency for the Federal Reserve to implement aggressive cuts to its short-term interest rates. In fact, the data suggests that The Fed could take a “more moderate approach in the short term” to its policy cycle, given the underlying strength of the labor market and the economy as a whole.
Even analyst firms that expected fewer rate cuts from the Fed lowered their expectations further after the September jobs data was released. Citi, Bank of America and JP Morgan were the consensus firms expecting fewer rate cuts in the quarter, and all three removed a rate cut from their base case before 2025.
The dollar benefits from the change of course
The divergence of the trajectories of the Fed and the ECB weighs on the price of the currency cross. Money is always looking for the most attractive (risk-adjusted) returns in the market, and it seems that the published macroeconomic data has convinced them that rates in the United States will have obstacles to falling quickly, unlike what is happening in America . what will happen in the euro zone. This turn in monetary policy is positive for the dollar, compared to the euro, and the exchange rate notices it: the price of the euro dollar has fallen by almost 2% over the last two weeks.going from $1.117 to $1.09.
The resilience of employment and the American economy in general thus becomes an ally for the country’s currency. The attractiveness of American debt is confirmed by the inflows of money it receives from foreign investors. In the case of Japan, one of the largest buyers of national debt in the international market, it is known that in August they purchased the largest amount of US debt in their history in a single month.
