The US Federal Reserve partially surprised the markets this Wednesday with a 50 basis point cut (the equivalent of two “natural” 25 bps cuts). This move has generated a small earthquake in the currency market: since the market began to offer options on this cut, the euro has appreciated sharply against the dollar. Over the last two months, the European currency has appreciated by around 3% against the dollar, including yesterday’s and today’s increases. The Fed did at one meeting what took the European Central Bank (ECB) years to do. Now the ball is once again in the court of the central bank of “almost all” Europeans and the rush is starting to come. In an environment of weak international trade and economic slowdown, a strong euro and weak credit growth can be “deadly” for the economy and the labor market. The Fed’s decision could push the ECB towards a cascade of rate cuts.
The Fed’s rate cut has brought the benchmark rate in the US back to a range of 4.75% to 5%. However, in the economic forecasts also published this Wednesday, the Fed suggests that rates will be at 4.4% in 2024 (equivalent to a range of 4.25% to 4.5%), reaching 3.4% in 2025 and 2.9% in 2026. The Fed has acted very quickly now, perhaps to act more slowly later. Yet in the eurozone, some voices have already begun to be raised to demand bring forward the “cascade” of rate cuts expected for 2025 at the next meetings or at least part of them.
“Although the ECB makes its decisions independently of the Fed, interest rate differentials relative to the Fed can have real economic effects in the euro area and therefore need to be taken into account,” says Marcello Estevao, chief economist at the IIF. “Otherwise, they would risk an appreciation of the euro, a drop in exports, a weaker economy and a disinflationary shock.”
In the same vein, Robin Brooks, Director General of the Institute of International Finance (IIF), issued a serious warning a few days ago: “The euro has risen against the dollar over the past year. This is entirely due to the fact that the ECB has been sending more aggressive signals on inflation than the Federal Reserve. The two-year rate differential has shifted in favor of the euro, leading to a rise in the euro/dollar parity.” “The ECB is making a mistake,” he said.
The ECB speaks out
I’m already counting on a “giant” cut in Fed ratesThis Wednesday (with an interview published this Thursday), the governor of the Portuguese central bank stood out, Mario Centenoto suggest that the European Central Bank might perhaps be forced to accelerate the pace of interest rate cuts: “Given the position we are in today, in the monetary policy cycle, we really need to minimise the risk of not achieving the intended targets, because that is the main risk,” the ECB Governing Council member assured in statements made to the magazine’s journalists Policy.
Centeno’s statements are the clearest sign yet that An interest rate cut in October remains a real possibilityas the ECB continues to grapple with the question of how to ease policy quickly in an economy that is struggling to regain momentum but is also struggling to beat inflation once and for all.
Debate within the ECB
ECB President Christine Lagarde suggested last week that there would be no further action before December. Other voices in the Governing Council have echoed the sentiment. Slovakia’s Peter Kazimir said Monday that “we will certainly have to wait until December to have a clearer picture before taking the next decision.” He added that “a significant change, a strong signal, in the outlook would be needed to consider supporting a further cut in October.” Shortly after, Lithuania’s Gediminas Simkus acknowledged that it was “difficult” to have a further cut in October with so little time having passed since September and said the eurozone economy was growing as officials had expected.
Some voices have been more cautious, such as ECB chief economist Philip Lane, who said Monday that policymakers “should maintain the optionality” of a taper in October. As has been the case at its recent meetings, the ECB is once again using rhetoric to leave all doors open and change its decisions as it gets more data, not just on the economy, but also on the rest of the central banks.
The oil price drop had already brought another rate cut in October closer, but the Fed’s decision adds a few more grams to the size of the cut, which seems to be taking the lead. On Wednesday, market punters were giving a 25% probability for an ECB cut in October, raising the probability to 30% after the Fed decided yesterday to “go all out”.
Centeno quickly questioned Lagarde’s message at last week’s meeting, arguing that the U.S. Federal Reserve didn’t need a major shift in economic data to change its tone, ultimately opting for a sharp 50 basis point cut. The pace of job creation has slowed in the world’s largest economy and some sectors of the economy have weakened, but gross domestic product continues to grow at a healthy pace. Employment also weakens in the eurozone And on top of that, the economy has not yet started: if the Fed cuts rates by 50 basis points, the ECB will have to do even more to keep the Old Continent’s growth chain oiled.
“The most recent data for the United States was worse than expected for the labor market, but it was not a big surprise either,” Centeno says. “Hope for a rapid improvement in the economic situation is visibly fading in Europe”. For Centeno, these data are part of a trend that shows a generalized disinflation. “We see less inflationary pressures coming from trade and, internally, from consumption decisions compared to savings decisions,” says the Portuguese.
Fed pressure on ECB
Some analysts have already warned of the pressure that the move by its counterpart across the Atlantic is putting on the ECB. “The Fed will continue, but the extent of the cuts to come will depend on the pace of the labor market,” while inflation will slow with the sharp drop in oil prices“The issue remains that of the ECB, whose reduction last week already seems ridiculous,” asserts Philippe Waecther, chief economist at Ostrum AM (Natixis IM), bluntly.
“The Fed’s half-point cut will have a ripple effect on other central banks’ interest rate decisions and lead market participants to conclude that the U.S. economy is slowing, which could lead to a global slowdown,” says Stefan Gerlach, chief economist at EFG Bank in Zurich and a former deputy governor of Ireland’s central bank. The ECB may be tempted to consider another rate cut in October, although it has “firmly rejected” it, Gerlach adds.
ECB officials, led by Lagarde, insist that they decide their policy independently. On the eve of the ECB’s first rate cut in June – when the US economy was still booming – Lagarde insisted that the measure would be data-driven, not Fed-driven. However, a recent study by the Institute of International Finance shows that. Rate changes in the US have been the main driver of policy decisions in Europe since 2021. What happens in October may or may not confirm this “precedent.”
