Six months ago, the main central banks of the world were poised to make a move that would delight everybody with a credit card, who wanted to buy a house, or who wanted to start a business: a worldwide shift to lower interest rates that would make loans more accessible and cheaper overall.

Rate cuts are “a topic of discussion out in the world and also a discussion for us,” Federal Reserve Chair Jerome Powell stated at a press conference in December of last year. At the time, investors were ecstatic about the prospect of looser financial conditions, and institutions like the International Monetary Fund were concerned that Powell and company would cut rates too quickly and jeopardise efforts to control inflation.

It turns out their worries were unfounded.

When major central banks faced inflation that turned out to be more persistent than anticipated and wage and economic growth that turned out to be more resilient, the coordinated relaxation of monetary policy that looked impending towards the end of 2023 has mostly failed.

A few small moves have been taken, like as the first cutbacks announced this month by the Bank of Canada and the European Central Bank.

The atmosphere in Frankfurt, London, Washington, and others has subsequently changed from the central bank equivalent of “start your engines” to something more close to “hold your horses.” But that was mainly to fulfil a promise made when inflation looked to be dropping quickly.

The first step towards loosening policy will be “consequential,” Powell said at a press conference last week. This is in response to new projections from Fed policymakers, which showed them expecting only one quarter-percentage-point rate cut by the end of the year, instead of the three they had projected in December and March. Powell had previously raised interest rates rapidly in 2022 and 2023 to combat inflation.

“When we do start to loosen policy, that will show up in significant loosening and financial market conditions,” Powell said. “You want to get it right.”

Instead of the four rate reduction anticipated in a survey conducted last December, when Powell shocked the markets by indicating a shift towards lower rates would occur rather soon, the majority of economists surveyed by Reuters now only anticipate one or two rate cuts this year. However, economists’ opinions have been more stable than market prices.

Six months ago, Reuters polled economists and they predicted that the Bank of England would not lower borrowing prices until the third quarter, contrary to the practically consensus forecasts that the bank will act in August. In contrast, market pricing from December of last year suggested a first cut in May and three more during the year.

Although headline inflation has dropped to almost exactly the BoE’s 2% objective, April’s inflation in the vital services sector was far higher than anticipated, and May’s 6% annual pay growth was still about double the target level.

Therefore, it is anticipated that the BoE would maintain rates during its final policy meeting under Prime Minister Rishi Sunak’s tenure, delaying the shift towards lower borrowing costs until after Britain’s election of a new administration.

Predictions by economists on the ECB’s initial action have also been accurate; a decrease in June was anticipated. However, market pricing has once again changed significantly: in December, it was hinted that there would be 140 basis points of decreases in the upcoming year, beginning in March.

As of right now, market prices hardly match one more rate reduction this year.

However, ECB officials have often warned of “bumps in the road” as they work to bring inflation back to goal, and they may have given the markets a heads-up by saying early on that the first decrease would not occur until June.

These “bumps” may now include the way that French President Emmanuel Macron’s decision to call an early legislative election has unsettled markets and raised the possibility of a far-right administration taking office in Paris the following month.

For the time being, however, ECB President Christine Lagarde and her staff are still mostly optimistic that inflation will continue to decline and reach the 2% objective by the end of 2025.

“Central banks are managing the trade-off between inflation and economic growth,” aware that overly restrictive policy could undermine a fragile recovery in the euro zone economy, ECB policymaker Mario Centeno said in an interview.

“In the end, the difference between now and a few months ago is not so big. The disinflation story is still intact,” the Portuguese central bank governor said.

As always, part of the narrative involves controlling expectations.

When the three-cuts-for-2024 scenario first surfaced in Fed policymaker estimates back in December, Powell warned that “no one is declaring victory” over inflation in his press conference following the meeting. However, the overall tone of his comments, opens new tab – mentioning “real” and “great” progress being made on inflation – seems to have solidified opinions that rate reduction were about to start.

Although Powell stated last week that the first cut will be “consequential,” marking the beginning of a predicted gradual decrease in borrowing rates, the precise date of the cut may not have as much of an impact on the macroeconomy.

The present stringent wording regarding reduction, at least from Powell, may perhaps be more about controlling expectations than the real outlook; that is, leaving the possibility open that rates may remain where they are longer than expected for some time to come.

Data released shortly before and after the Fed meeting last week clearly suggested that price pressures were fading. Investors have mostly ignored Powell’s remarks and the Fed officials’ revised estimates, continuing to bet on rates falling starting in September.

However, the decline has been significant, with major central banks now permitting “restrictive” monetary policy to have an unanticipated, months-long negative impact on families, companies, and banks. Some are concerned that may lead to a breaking point.

“Continued restrictive policy risks pushing labor demand down too much and pushing unemployment higher than the current 4%, which the Fed is projecting for the end of the year,” Nick Bunker, the economic research director for North America at the Indeed Hiring Lab, wrote in response to last week’s Fed decision. “The labor market has seemed invincible for much of the past two years, but its armor can’t last forever.”

(Adapted from Reuters.com)

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