Policymakers across Europe are showing caution when it comes to following the Federal Reserve’s aggressive path of cutting interest rates. As the Fed initiates a rapid easing cycle with a half-point rate cut, the Bank of England (BOE) and European Central Bank (ECB) are signaling a more measured approach, widening the transatlantic policy divide.
In Europe, central banks are emphasizing a gradual reduction in borrowing costs. The BOE, for example, pledged a slower pace of rate cuts in response to inflation, while the ECB has reaffirmed its data-dependent stance. Meanwhile, Norway’s central bank made it clear that rate cuts are unlikely this year, further highlighting the contrast with the U.S. Federal Reserve’s more aggressive actions.
This divergence reflects different economic environments. In the U.S., inflationary pressures have cooled, allowing the Fed to pivot toward supporting economic growth and employment. However, European central banks are treading carefully, as wage-setting mechanisms and inflation risks differ across the Atlantic.
The Fed is expected to cut rates by another 70 basis points by year-end, while markets anticipate a slower easing process in Europe. The BOE, in particular, remains focused on controlling inflation and does not foresee an immediate rate cut, despite investors expecting a reduction in November. This cautious stance sent the pound to its highest level against the dollar since March 2022, with market bets on a quicker loosening pared back.
In contrast to the Fed’s bold actions, European central banks are concerned about the impact of inflationary risks, particularly wage growth and tight labor markets. Governor Andrew Bailey of the BOE emphasized that services inflation remains elevated and warned of a “gradual path down” for borrowing costs. Norway’s central bank echoed this sentiment, maintaining its key rate at a 16-year high due to concerns over inflation driven by a weak krone.
ECB officials, including Klaas Knot, have indicated a cautious stance, suggesting further cuts will only follow if inflation cools. Investors are betting on one or two more quarter-point moves by the ECB in 2024, but other ECB members are signaling that significant rate cuts are unlikely until December.
Although Europe’s larger economies are lagging behind the Fed’s easing cycle, some analysts expect the gap to narrow. Tim Drayson, head of economics at Legal & General Investment Management, predicts that wage pressures across Europe will decline, enabling the ECB and BOE to speed up rate cuts next year. However, external events, such as the upcoming U.S. presidential election, could introduce new challenges for both European and U.S. central banks.
David Page, head of macro research at AXA Investment Managers, suggests that the election outcome could affect inflationary policies in the U.S., influencing the Fed’s ability to maintain its pace of rate cuts. As central banks across the globe navigate these evolving dynamics, the contrasting approaches to monetary policy highlight the complexities of managing inflation, economic growth, and financial stability in different regions.
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