Global rate cuts: central banks in the hot seat

By the OFX team | 16 April 2024 | 4 minute read

When setting interest rates in the post-pandemic recovery phase, central bankers took a line from the Yazz 1988 dance floor hit, The Only Way is Up.

But last month, Switzerland’s central bankers decided not to groove to the beat, posting the nation’s first official rates cut since last June. The monetary gatekeepers from Zurich deemed that inflation was under enough control, while the economy was fragile enough to warrant the measure.

While other wealthy countries are still expected to follow suit the expected timing of the long-anticipated cuts is being pushed back – especially in the US. The key reason is that inflation has not been vanquished and a key driver of that is the rising oil price on the back of escalating Middle Eastern tensions.

A crude tool

Central bankers have used interest rate settings as a crude – but usually effective – weapon to temper overheated economies.

But too much tough medicine can spur a recession and that’s why the market now expects the next movements to be downwards. Getting it right is tricky because lower rates tend to depreciate the national currency, leading to higher prices on imported goods and more inflation.

In the US, equity and bond markets have plunged on the back of March inflation figures showing the annualised rate at 3.5 per cent, well above the Federal Reserve’s 2 per cent target.

That was enough for economists to abandon expectations of a rate cut by June, with September now looking the best bet.

What the central bankers say

Central bankers have been tempering expectations of a significant monetary easing, with settings likely to remain restrictive.

“It will likely be appropriate to begin dialling back policy restraint at some point this year,” says US Federal Reserve Chairman, Jerome Powell.

European Central Bank President, Christine Lagarde is equally non-committal: “What we have done is that we have just begun discussing the dialling back of our restrictive stance.”

The Bank of England’s monetary policy committee “recognises [its] monetary policy stance could remain restrictive even if the bank rate were to be reduced, given that it was starting from an already restrictive level.”

The risk of overshooting

With an eye firmly on the November election, US President Joe Biden declareds that inflation remained his “top economic priority”, with prices still too high for housing and groceries.

But he adds: “I do stand by my prediction that before the year is out, there will be a rate cut.”

The Financial Times also notes that it is impossible for central banks to hold off on cuts until they are 100 per cent sure inflation has been quashed, because rate cuts take months to have an effect.

This raises the case of overshooting on rate rises, which looks to have been the case in Switzerland where unemployment is rising higher than the nation’s lofty alps.

The Swiss National Bank cut rates to 1.5%, from an already low 1.75%. But unlike the country’s famed watches the bank the timing may have been a bit late.

Japan bucks the trend

On the flipside, Japan’s central bank last month raised rates for the first time in 17 years, from -0.1 per cent to zero-0.1 per cent.

The Bank of Japan had kept rates at such ultra-low levels to spur the nation’s insipid economy, but recent indicators suggest an outbreak of ‘healthy’ inflation as opposed to ratcheting wages.

Of all the developed economies, Japan’s monetary policy looks to be a quirky outlier.

Oil’s well that doesn’t end well?

The wildcard in the inflation struggle is the deepening of the Middle Eastern conflict. The price of benchmark Brent crude has gained around 25% year to date.

“Along with the unfortunate humanitarian costs, the latest escalation of hostilities in the Middle East poses new risks to efforts to reduce global inflation,” says Betashares chief economist, David Bassanese.

“Iran is one of the world’s leading oil producers, and any disruption to its capacity to supply global markets could see oil prices rise further, pushing up global inflation from still overly high levels,” Bassanese says.

“In turn, this outcome would make it difficult for central banks to contemplate the interest rate cuts later this year that both equity and bond markets around the world are now counting on.”

He notes that despite lingering trade sanctions, Iranian oil exports have lifted strongly over the past few years “with the United States seemingly passively accepting this, as a means to keep downward pressure on world oil prices and US inflation.”

It’s a moot point as to how much longer Uncle Sam will retain this stance.

What are the odds?

Meanwhile, the yield on benchmark US ten-year treasury bonds has jumped to 4.5 per cent, a 9 per cent increase over the last month and the highest level since mid-November last year.

The two-year treasury rate is at 4.88 per cent. Given the cash rate stands at 5.5 per cent this reflects market expectations of an easing, but the doubt lies in the timing and quantum of the measure.

According to CME Group’s gauge of the expectations of interest rate traders, there’s a mere 6 per cent chance of the Federal Reserve cutting at its May 1 meeting, compared with a 23 per cent chance a month ago.

The odds increase to an 87% chance of a rise at the Fed’s November 7 pow-wow, compared with 68% a month ago.

In recent times the market has proved to be wrong on rates, but at least stressed mortgagees can be assured that, unlike the song, the only way is not up but perhaps a holding pattern for longer than expected.

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