Interest rates heading lower after historic week for central banks

The world’s major central banks are now all clearly in the early stages of a monetary easing cycle that could end up lasting for well over a year.

Over the past couple of months, the US Federal Reserve, the Bank of England, and the European Central Bank (ECB) have all cut interest rates for the first time in years.

For many central bankers, concerns about sluggish growth and the health of the labour market are now as prominent – if not more so – than fears about inflation, paving the way for an extended period of rate cuts.

“Investors need to prepare their portfolios for a world of lower interest rates,” Dean Turner, chief European economist at UBS Global Wealth Management said.

The Fed waited longer than either the Bank of England or the ECB to begin cutting interest rates, but its 50 basis point cut sent a very clear message that rates are on their way down.

Speaking in the wake of the historic decision, Jerome Powell explained the decision was motivated by a desire to ensure that high interest rates did not do unnecessary damage to the economy.

“The labour market is actually in solid condition, and our intention with our policy move today is to keep it there,” he said.

Fed officials forecast that the federal funds rate would stand between 4.75 and 4.50 per cent by the year’s end, implying either two further rate reductions or one bumper cut.

While Powell did his best to dampen bets the Fed was poised for a rapid reduction in interest rates, many investors were not convinced.

“The September FOMC meeting signals an important dovish shift in the Fed’s reaction function,” Frederik Ducrozet, Head of Macroeconomic Research at Pictet Wealth Management, said.

“Chair Powell wants to be more pre-emptive in securing a soft landing and his tolerance for further softness in the labour market seems quite low”.

The Bank of England

The Bank of England’s decision to hold rates, having reduced them in August, was less attention-grabbing than the Fed’s, but rate-setters were still confident that restrictiveness could be dialled back as the year progressed.

“The economy has been evolving broadly as we expected,” Andrew Bailey, governor of the Bank, said. “If that continues, we should be able to reduce rates gradually over time”.

Although the Bank is likely to move slower than the Fed, many economists think it will resume its cutting cycle in November and cut rates once a quarter thereafter.

The big question is whether the underlying economy will deteriorate quicker than the Bank expects, forcing them into a more aggressive cutting cycle.

Ian Stewart, chief economist at Deloitte, suggested “softer job and wage data” would nudge the Bank towards more rapid rate cuts. “UK interest rates could easily be as low as four per cent by spring,” he said.

The ECB, which announced its second rate cut last week, is in the unenviable position of facing sluggish growth alongside some stickier inflationary dynamics.

Inflation fell to 2.2 per cent in August, its lowest level since July 2021. However, services inflation actually accelerated in the month, pointing to residual price pressures.

On the growth side, the ECB forecast this month that the eurozone economy would only reach its potential growth rate in mid-2025, a year later than it predicted in June.

Despite this likely weakness, Christine Lagarde, president of the ECB, did not provide any clues about the future path for rates at the September meeting.

Like the Bank, markets expect the ECB to cut rates once more before the end of the year. One thing is for certain though, as 2024 approaches its conclusion, central banks will remain at the heart of the action.