The major central banks of the West have all maintained unaltered interest rates in recent days, but they have taken very different stances towards the market’s much-anticipated 2024 rate decreases.

The Federal Reserve of the United States sent risk markets into a tailspin on Wednesday when it disclosed that policymakers were planning at least three rate cuts for the upcoming year and four more for 2025, in addition to maintaining the benchmark rate at its current target range of 5.25% to 5.5%.

Based on CME Group’s FedWatch tool, markets are pricing in the first 25 basis point reduction in March and anticipate a 150 basis point drop in the Fed funds rate by year-end.

The market had anticipated three rate cuts, but the Fed surprised markets by signalling a dovish move that drove the Dow to a new high and bond yields plunging—the 10-year U.S. Treasury yield fell below 4% for the first time since July.

The annual rate of U.S. headline inflation in November was 3.1%, which is still higher than the Fed’s target of 2%. However, it is much lower than the peak of 9.1% recorded in June 2022 during the pandemic. But the core number, which eliminates fluctuating energy and food costs, remained constant at 4%.

In the meantime, economic activity has shown remarkable resilience, as seen by the third quarter’s 5.2% annual GDP growth.

In his press conference on Wednesday, Fed Chair Jerome Powell recognised that rate cuts had now started to “come into view.” This realisation caused some analysts and big lenders to modify their projections for future rate hikes.

Among them were American economists at Barclays who, after first predicting just one rate decrease in December 2024, now anticipate three reductions at each of the next six meetings, beginning in June.

“We were surprised by the FOMC’s reluctance to push back against the notable easing of financial conditions over the past month or so,” they said.

“Not only did the statement cite ‘tighter financial and credit conditions…’ as in November, but the SEP [summary of economic projections] also showed a slightly downgraded GDP growth projection for 2024 despite less restrictive conditions for aggregate demand. Powell expressed no concern that such easing might undermine the FOMC’s objectives.”

The economists at the British lender put upside risk on their estimates despite the dovish adjustment in the rate call. They said that the recent loosening of financial conditions “may boost growth and ultimately result in stalling disinflation.”

However, the situation is quite different on the opposite side of the Atlantic. On Thursday, the European Central Bank and the Bank of England both defied market expectations by highlighting ongoing pressures on wages and prices in the country.

The Bank of England warned that monetary policy is “likely to need to be restrictive for an extended period of time,” but it refrained from discussing rate decreases. The main interest rate remained at 5.25%.

October saw a two-year drop for headline inflation in the United Kingdom, which was nevertheless much higher than the Bank’s 2% target. Although recent wage growth has fallen short of forecasts, at over 7%, it is still uncomfortably high for the central bank.

Although tighter monetary policy is causing a looser labour market and dragging on activity in the real economy, the BOE’s Monetary Policy Committee stated that “key indicators of U.K. inflation persistence remain elevated.”

In October, the economy unexpectedly contracted by 0.3% month over month, despite the real GDP of the United Kingdom remaining flat in the third quarter.

According to S&P Global, the BOE still has a difficult time figuring out when to begin easing, particularly in light of criticism that it has been reluctant to address runaway inflation, which peaked at 11.1% in October 2022.

Principal Economist Raj Badiani stated that the MPC is not yet prepared to consider rate cuts against a backdrop of persistent service inflation, which has put regular earnings growth on a “troublesome trajectory.” The 6-3 voting pattern on Thursday in favour of holding rates steady, with the three dissenting members favouring another 25 basis point hike.

“We expect four interest rate cuts next year with the first to occur in August 2024. However, we acknowledge that this could be impacted adversely because of still strong service and core inflation and unsustainable earnings growth,” Badiani said.

“Monetary policy is very restrictive which is likely to trigger a mild recession in the coming quarters. In addition, the economy is likely to contract marginally in the full-year 2024.”

In addition to holding rates, the European Central Bank also revealed plans to accelerate the reduction of its balance sheet and downgraded its growth and inflation projections.

“The Governing Council’s future decisions will ensure that its policy rates will be set at sufficiently restrictive levels for as long as necessary,” the ECB said in its accompanying statement.

The phrase “expected to remain too high for too long” was replaced with “decline gradually over the course of next year” to describe inflation, nonetheless.

The year-over-year inflation rate in the euro zone has decreased from 10.6% in October 2022 to 2.4% in November, which puts the ECB’s 2% target within reach, despite warnings from authorities that volatility in the energy market and wage pressures could spark a return.

The ECB’s inflation estimates were downgraded in the near term, but there was an unexpected upward revision to 2025 core inflation, and the revised 2026 forecasts maintained core inflation above target by the end of the projection horizon.

“Despite the hawkish messaging at [Thursday’s] meeting, the recent run of softer than expected inflation data, the Fed’s pivot, as well as the softening in rhetoric from a number of prominent members on the Governing Council, has shifted the balance of risks around the ECB’s policy trajectory,” said Peter Schaffrik, global macro strategist at RBC Capital Markets.

“While we continue to expect that the ECB will keep rates unchanged in 2024, we think that the risks are now tilted firmly towards earlier rate cuts.”

The news conference given by ECB President Christine Lagarde, however, was seen differently. Some economists saw her overall statement as providing an opening for rate decreases in 2024, even though she tempered market expectations for a first move as early as March.

“While [Lagarde] emphasised that the ECB’s approach is data-dependent rather than time-dependent, she dropped at least four hints suggesting that a first cut seems more likely from June 2024 onwards rather than in early 2024,” said Berenberg Chief Economist Holger Schmieding.

The ECB’s projections for headline inflation to fall to 2.1% in 2025 are based on market expectations for 3-month average overnight interest rates, which cut off at 23 Nov.; current market pricing is not taken into account. Other hints included a reference to a “plateau” between the last hike and the first cut, emphasis on the resilience of domestic and mostly wage-driven inflation, and a barrage of new data due in the first half of 2024.

“Tellingly, the ECB monetary policy statement did not change the wording on the rate outlook. As before, the ECB vowed to set rates at ‘sufficiently restrictive levels for as long as necessary’ to ensure a return of inflation to the 2% target. We continue to expect a first 25bp cut in Q3 2024,” Schmieding said.

(Adapted from CNBC.com)

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