It’s rare you get a clean take from central bankers, but Federal Reserve Bank of Chicago President Austan Goolsbee didn’t mince his words on Monday. He said interest rates need to be lowered “significantly” to protect the US labor market and economy. He advocated “many more rate cuts over the next year.” Now that’s forward guidance even an aging journalist like me can comprehend. Europe should act just as aggressively.
The Fed’s confident messaging diverges dramatically from the dithering coming out of the Bank of England and the European Central Bank. Both cut rates before the Fed, but if there’s such a thing as first-mover advantage it’s been lost again by another bout of hand-wringing. The institutional wait-and-see mindset risks repeating the mistake of 2021 by taking too long to send definitive monetary policy signals. By only lowering interest rates by 25 basis points a quarter, both central banks aren’t leading but simply reacting to backward-looking data. It’s treading water for no discernable purpose.
They should be channeling the decisiveness of the Fed, which made a bold 50-basis-point start to its rate-cutting cycle, taking an insurance measure against an economic downturn. If the US economy fares better, it can pause. This comes even though September’s composite purchasing managers index is robustly in the expansion zone at 54.4. US inflation at 2.5% isn’t down to target, yet the Fed is clear it’s shifting focus to the employment side of its mandate.
European rate-setters are falling behind the curve, which narrows their options. Reducing official rates twice more this year, rather than just the once, would enhance their ability to manage a slowing economy and prevent being forced into 50-basis-point cuts. If they prevaricate much longer these may become inevitable.
September purchasing manager surveys show increasing risks of recession in the euro zone. France, along with Italy, faces a very difficult autumn preparing a budget that passes muster with the European Commission in Brussels. Both countries have been placed in its Excessive Deficit Procedure, which will likely require considerable fiscal tightening at the worst possible time.
There’s no respite in sight with the Chinese economy struggling badly, affecting European exports ranging from industrial to luxury goods. China unveiled more stimulus and rate cuts this week, but so far none of its measures have made any discernable impact.
Bloomberg Economics expects euro-area growth this year of 0.7%, but it’s only positive due to southern European countries doing the heavy lifting, while France and Germany stagger. Inflation is expected to fall below the ECB’s 2% target next year. Prior to the pandemic, the euro area spent a tortuous decade fighting deflation. It must avoid a return to this debilitating trap.
The Bank of England’s dilemma is perhaps less bleak but is also stricken by inertia that is overlooking a potentially fast-changing economic backdrop. Inflation has fallen back very close to the 2% target, and growth flatlined in both June and July. UK consumer confidence has taken a knock from an unremitting message of doom and gloom from the new Labour government.
Chancellor of the Exchequer Rachel Reeves’ first budget will have been delivered by the BOE’s next quarterly review on Nov. 7. A second rate cut to 4.75% is more than fully priced in. A subsequent cut at its Dec. 19 meeting is more of a coin flip as the mood music from Governor Andrew Bailey is all about a “gradual downward path.”
However, the most prominent hawk on the Monetary Policy Committee, Catherine Mann, has raised the prospect of faster rate cuts when inflation risks are over, detailing in an important speech on Friday how her approach may change. Mann also highlighted the risks to the UK, and by implication the rest of the world, of the spillover effects of an aggressive Fed rate-cutting campaign. Although she argues for caution, actually the simplest way to handle that is not to get let too large an interest-rate gap grow between the major central banks. It would also reduce potential sharp moves in the currency markets.
Steady, but at a little bit quicker pace, would be the safest way for both the ECB and BOE to approach rate-setting over the rest of this year. That means two quarter-point cuts, not just one, by year end. That’ll put Europe in a far stronger position to handle come what may in 2025.
Credit: Bloomberg
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