Global economy: Lower central bank rates and then what?

Further progress in terms of disinflation and the room this creates for central bank easing seem to be the only economic ‘certainties’ for 2024. What is left is a list of important questions that should be answered as the year progresses. What will be the pace and extent of rate cuts? Is there a risk of underestimating the impact of past rate hikes that still must manifest itself? What about the timing and strength of the pickup in growth in reaction to lower inflation and the start of policy easing? Is there a downside to the scenario of a soft landing in the US? The answers to these questions matter for the real economy but are especially important for financial markets and the policy rate expectations.

From a macroeconomic perspective, one of the defining characteristics of 2023 was the ongoing tightening of monetary policy, with the Federal Reserve and the ECB raising rates more than expected. These decisions, in combination with accumulating evidence in the latter part of the year of a clear downward trend in core inflation, changed the outlook for interest rates for 2024. 2022 was the year of the start of a tightening cycle, 2023 saw the terminal rate being reached and 2024 should be the year of cuts in official interest rates. In the US, the FOMC members’ December projections pencil in three 25 basis points cuts in 2024. The message from the ECB is more opaque although recent comments of several governing council members suggest that the debate has clearly shifted from whether further hikes are warranted to how long rates should be kept at present levels. The consensus expects the ECB to start reducing rates in July, bringing the deposit rate back to 3.25% by the end of the year, compared with the current level of 4.00% (chart 1).[1] A similar survey in the US expects the first rate cut by the Fed in June and a cumulative reduction of the federal funds rate this year of 125 basis points.[2] It is safe to conclude that there is hardly any or even no debate on the question whether policy rates will go down this year. Further progress in terms of disinflation should warrant a reduction in official interest rates, if only to avoid that otherwise, real interest rates would increase thereby causing an unwanted further tightening in the monetary environment.

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