When will the interest rate cut occur
In the UK, US and Eurozone, rates are now close to their peak and central banks have said they will cut rates in the first part of 2024. Analysis by Steven Bell, Chief Economist EMEA at Columbia Threadneedle Investments
When might interest rates fall?
It may seem like a strange question to ask so soon after the latest rate hike by the European Central Bank and ahead of this week's Fed and Bank of England meetings. The latter will probably increase rates, while the US Federal Reserve is preparing to keep them steady, while confirming its desire for further possible increases. Even the Bank of Japan, after keeping official rates in negative territory for many years, now expects an increase, although not before the end of the year. It is natural, therefore, to wonder when rates might fall. In the UK, US and Eurozone rates have reached, or almost reached, their peak and the respective central banks have declared that rate cuts will take place when they feel confident that inflation is moving sustainably towards the target of 2 %.
When will the first cuts take place?
We expect the US to reduce interest rates in early 2024 and the UK and Eurozone to follow soon after. If this were the case, it would be a pleasant surprise for the market, which now estimates that rates will remain at current levels, or above, until well into 2024. We are, in fact, clear that monetary policy operates with long and variable lags. Central banks try to look ahead, tightening policy before inflation takes off and easing before recession hits. The problem is that they collectively failed to predict the current surge in inflation. They have lost confidence in their forecasting models and now claim to be “data dependent,” without providing details on exactly what this might mean, beyond repeated claims that interest rates could rise further and are likely to remain high for a while. prolonged period. However, unemployment could change the current hawkish attitude, currently near or below historic lows in all three economies. With inflation above target, it is easy for central banks to use a tougher tone.
Personally, I believe unemployment is set to rise in all three economies. The United States is the economy with the best fundamentals, but even here job growth is slowing steadily. The quarterly average of private sector employment gains in the United States is 140,000. That may seem like a lot, but it's down from 200,000 three months ago and those before that. And this is important because the job offer, especially thanks to the recovery of immigration, is increasing by 200,000 units per month. Unemployment looks set to rise and could probably reach the threshold of the Sahm rule, which has precisely identified past recessions, by Christmas. Furthermore, although inflation remains above target, the core CPI inflation rate over the past three months has fallen to 2.4%, a notable decline.
In the UK, employment is falling and the upward trend in unemployment appears to be consolidated. The problem the BoE faces is that wage inflation is well above the level consistent with its 2% target. The underlying inflation rate is also too high, although this could change given the data released this week. The BoE needs concrete evidence that the weakening labor market is slowing the pace of wage inflation before it can even begin to consider a rate cut. But this could happen sooner than many think: polls already indicate a marked slowdown in wage pressure.
Finally, in the Eurozone unemployment is at historic lows and continues to fall. Unemployment is usually a lagging indicator and data suggests that the eurozone has already entered recession. Unemployment is therefore likely to rise soon and, although the ECB will need to be convinced that this dynamic will then translate into a reduction in wage and price inflation before considering a cut, this should be evident by next spring. Encouragingly, the recent surge in inflation has not raised long-term inflation expectations much. There is a good chance that the reduction in global inflation will quickly translate into lower wages, with the wage/price spiral reversing. A similar dynamic is already evident in the United States.
Therefore, we are moving towards rate cut time, which, once it arrives, is expected to be particularly significant and much larger than currently expected. This should bring relief to all financial markets. The battle against inflation has been tough – much tougher than many expected – but the tide has turned and we should see the fruits of the victory before long.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/quando-taglio-tassi-interesse/ on Sun, 24 Sep 2023 05:31:48 +0000.