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ECB rate cut signals the beginning of a global easing cycle

ECB rate cut signals the beginning of a global easing cycle

And so it begins, the global easing cycle.

The European Central Bank (ECB) and Bank of Canada cut policy rates this week, following the Riksbank (Sweden) and Swiss National Bank (SNB) earlier this Spring – firing off the starting gun of a new global monetary policy cycle.

This part of the cycle, is much better for markets, as it’s characterized by disinflationary forces on the one hand and improvement in growth on the other.

Make no mistake, inflation continues to be above target in many economies, though it’s certainly come off its highs and it has declined enough in places like the Eurozone for the ECB to make a cut.

What’s important here is, that the pathway to the ECB’s medium-term inflation target has become more clear.

Central banks around the world do not operate in a vacuum, as they are linked by interest rate differentials but also respond to common supply and demand dynamics.

While this week’s monetary policy pivot in Europe may have less of an impact on the Fed’s path forward, it certainly radiates an easing bias especially to EM and the broader APAC region.

ECB Rate Action

The ECB commenced its rate cutting cycle this week taking the deposit rate from 4.0% to 3.75%,1 in-line with consensus expectations, though their forward guidance appears to be hawkish and the bank is likely to proceed with caution. 

I do not believe that this is the start of an aggressive cutting cycle, with probably only 2 more cuts remaining for the rest of the year. The next rate cut most likely won’t happen before September.

While markets may have focused on the rate cut itself, I believe that the more interesting tidbit comes from the ECB’s updated growth and inflation projections.

Both core and headline inflation are expected to average 2.2% next year, up from 2.1% and 2.0%, respectively.1 On the growth side, the ECB now projects GDP to expand 0.9% this year, up from 0.6%. 1

I also note the slightly more hawkish language in the policy statement that the bank “is not pre-committing to a particular rate path” which I believe is the reason why Bund yields saw a bounce.

These updated projections and slightly hawkish policy statement lead me to surmise that the ECB wants to project the image that it is unlikely to earnestly cut rates this year though President Lagarde explicitly stated more dovish views in the press conference that disinflation in the EZ was on track. 

The Fed

While certain parallels could be made between the EZ and the US economies, let me just point out that America’s disinflationary path has been slower and made more complicated because the labor situation remains robust. 

And while recent US economic data such as retail spending has started to stall, underlying conditions are notably stronger and coming off a higher base when compared to the EZ.

Because inflation risk aversion permeates the Fed, I believe that the US employment levels holds the key to when we can expect a rate cut.

The easing path is likely to be paved with more slack from the labor market. While the Fed may need to see sequential months of concrete disinflationary data before a cut, I believe that they are likely to cut with the first sign of realized labor market weakness. 

While this week marks the beginning of the global easing cycle, with the Fed likely to play catch-up later this year, I believe that the biggest question here, is what the new normal for rates, or R*, is going to look like.

It’s tough to think that we are ever going to move back to pre-COVID levels, though the path towards this new phase has recently been made more clear.

Growth, inflation and rates are normalizing around the world, though to what level, remains to be seen. 

 

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

Reference:

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    Source: European Central Bank, as of June 6, 2024

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