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High interest regime over? ECB, BoC loosen monetary policies

ECB President Christine Lagarde said that the central bank needs more time to conclude that inflation is firmly on a path to its target of 2%

The European Central Bank (ECB) and the Bank of Canada (BoC) became the latest major central banks to loosen their policies, as emerging markets rapidly advanced in their efforts to reduce interest rates in June 2024.

Three of the nine central banks in charge of the world’s ten most traded currencies lowered their lending benchmarks, with Switzerland implementing the second rate cut of the cycle.

Since March 2020, when policymakers lowered rates to support faltering economies in the face of the COVID-19 outbreak, June has seen the greatest number of rate cuts from G10 central banks.

In the meantime, lending rates were left unchanged in June by the Bank of England, the United States Federal Reserve, and the central banks of Australia, Sweden, Norway, and Japan, all of which lean toward tightening rather than easing policy.

“We’re on this global disinflation path – it’s just probably a bit slower than what we’d hoped for six months ago. We started to see G10 central banks cut rates – Sweden, Switzerland, Canada, and the ECB. I have confidence that the Federal Reserve will cut rates this year as well, maybe even a couple of times,” Paul Greer, portfolio manager at Fidelity International said.

It is now anticipated that the Fed will lower interest rates by a full quarter point in November 2024. Central banks in emerging markets have persisted in their effort to lower interest rates, albeit more slowly.

At rate-setting meetings in June, four of the eighteen central banks in developing economies announced rate cuts. The central banks of Chile, Colombia, the Czech Republic, Brazil, and Colombia all lowered lending rates by 150 basis points.

According to Ray Jian, an Amundi portfolio manager, “The Fed hasn’t been cutting as aggressively as markets (had expected).”

He also mentioned that emerging markets had unique factors that hindered the rate of easing in developing countries, particularly in the fiscal domain.

ECB President On Inflation

The ECB needs more time to conclude that inflation is firmly on a path to its target of 2%, and benign economic developments indicate that rate cuts are not urgent, the central bank’s President Christine Lagarde has said.

“It will take time for us to gather sufficient data to be certain that the risks of above-target inflation have passed. The strong labour market means that we can take time to gather new information,” Lagarde told the ECB Forum on Central Banking, the bank’s hallmark policy conference.

As per the analysts, the ECB is trying to walk a narrow path, reconciling inflation uncertainty and weak growth. Uncertainty may warrant caution in cutting rates, but persistent economic weakness strengthens the case for easing.

Acknowledging the above dilemma, Lagarde warned that it was still not a given that the bloc would avoid a recession despite a modest growth uptick last quarter.

“A ‘soft landing’ is still not guaranteed. We also need to be mindful of the fact that the growth outlook remains uncertain,” the official stated further.

In recent weeks, growth indicators have been on the weaker side of expectations, challenging a widely held view that a year and a half of economic stagnation was over and a recovery was taking hold.

Still, investors are betting that inflation concerns will outweigh recession fears and the ECB will be very slow in cutting rates, especially since the United States Federal Reserve also signalled patience.

They now price between one and two more cuts in 2024 and only four cuts by the 2025 end. Price growth is expected to hover around 2.5% for the rest of the year before falling back to the ECB’s 2% target by the 2025 end.

While disinflation has been relatively quick over the 2023, high service costs threaten to derail the process and policymakers are now focusing on whether firms are starting to absorb quick wage growth or pushing higher wages onto customers.

“We are still facing several uncertainties regarding future inflation, especially in terms of how the nexus of profits, wages and productivity will evolve and whether the economy will be hit by new supply-side shocks,” Lagarde concluded.

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