Fed vs ECB: Interest Rate Debate Rages On

Will the European Central Bank (ECB) overtake the Federal Reserve when it comes to cutting interest rates? This is the question that has sparked analysts’ jitters as the eurozone’s central bank could lower borrowing costs at the start of the summer while forecasts regarding Fed’s rates have changed since the beginning of 2024.

The reason behind the debate is that the Fed has witnessed the release of several economic reports depicting the US economy not losing as much steam as needed, although the central bank raised rates to the highest level recorded in years.

In this article we will share some interesting insights regarding the Fed and ECB policies and analyst forecasts.

ECB Keeps Interest Rates On Hold

On April 11th, the ECB’s governing council convened to discuss monetary policy. After the meeting, the ECB announced that it would keep interest rates unchanged, a decision that was largely expected by economists. While markets had foreseen this move, most analysts were expecting to see how ECB’s policymakers could give hints about a potential rate cut in the next meetings.

The ECB did not disappoint as in its post-meeting statement it was mentioned: “If the Governing Council’s updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission were to further increase its confidence that inflation is converging to the target in a sustained manner, it would be appropriate to reduce the current level of monetary policy restriction.”

Commenting on the statement’s content, some economists suggested that it did not contain the strong wording that perhaps some anticipated but does not rule out an interest rate cut in June. As the ECB vowed to remain “data dependent” regarding its decisions, it has become clear that it plans to adjust its policy based mainly on inflation data but also wage growth etc.

Lagarde: Won’t Wait For Inflation To Decide On Rates

The ECB’s head Christine Lagarde said that the governing council won’t wait for inflation to fall to the 2% target before taking action. Lagarde noted that the board wouldn’t pre-commit to a particular rate path, adding that some board members “felt sufficiently confident on the basis of the limited data that we received in April" to back a rate cut.

The ECB’s chair stressed that the eurozone’s central bank isn’t dependent on the Federal Reserve and that nobody can assume that eurozone inflation would mirror US inflation. Lagarde stressed that she wouldn’t speculate on what other central banks might do and reiterated that inflation in the US and the euro bloc have different characteristics.

Fed Faces An Economy That Runs Hot

In the US, the Fed faces different issues regarding economic conditions. Even though inflation has fallen closer to the bank’s target than it was a year ago, the economy seems to be in overdrive, demonstrating exceptional adaptability to the highest level of rates recorded in the last decades.

On Wednesday April 10th, the Bureau of Labour Statistics (BLS) published the March CPI inflation report, revealing that prices rose by 3.5% on an annualised basis. The figure surpassed analysts’ expectations and dashed hopes for a borrowing cost reduction in summer. While real average earnings remained flat in March  according to a BLS report on April 10th, the NFP figures were another unfortunate surprise for the Fed’s governing board. The report showed that 303,000 jobs were added, 30% higher than anticipated by economists.

As 2024 started, many economists had suggested that the Fed could lower rates in June but, after this week’s CPI data release, the CME FedWatch tool gives only a 20% chance (12.04) for this to materialise.

Economists Highlight Differences Between US And Eurozone Cases

DeAnne Julius, a former Monetary Policy Committee (MPC) member, told CNBC reporters that the Fed could reduce interest rates before the ECB does. “I suspect that the Fed will be the first to really put a cut in. The labor market adjusts more quickly.  I don’t think the Fed will move very much, but I suspect that there could well be a little move there, somewhere, towards the second half of the year. The ECB, [it] takes them a while to reach consensus. Because the situation is, inflation is far too high in some of the countries still, and below their 2% target in others. So, you know, theirs is not really an economic analysis, it’s partly a political and an internal weighting of the different economies and the different politics in the different economies,” she noted.

On the contrary, Yannis Stournaras, one of the ECB’s board policymakers, said: “Now it’s time to diverge. The situations in the euro area and the US are completely different. In the US, demand is much stronger — mostly stemming from a push coming from the budget. We don’t have that in Europe. And inflation in the euro area was mostly supply-side led — not demand-side led, not led by wages.

ING: June Cut Possible, But Thereafter Still Uncertain

Economists at ING noted that “while Lagarde sought to underscore a decoupling of eurozone inflation dynamics from those in the US, she continued elaborating that anything that matters would find its way through the upcoming projections in June. Our economists pointed out that the US inflation did have a good six-month lead on the broader direction of eurozone inflation developments.”

In their report, published on April 11th, they suggested that “we could see a policy divergence between the ECB and Fed in coming months, putting further widening pressure on the 10Y UST-Bund spread, which widened to 210bp after the meeting. But the spread widening could be a tad milder than had the ECB signalled more confidence about domestic inflation dynamics and potential easing beyond June.”

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