The ECB has delivered a quarter-point interest rate cut, marking its second reduction in the deposit rate this year. The widely anticipated move comes after sluggish economic growth across the Eurozone and cooling inflation. The ECB has also lowered its 2024 growth forecast to 0.8% down slightly from the earlier projection of 0.9%, citing weaker contribution from domestic demand over the next few quarters. Recessionary and demand fears are back for Europe and the US. Could there be a demand reversal anytime soon?
Geoffrey Dennis: Yes, there could be a demand reversal. It is probably unlikely in Europe. Frankly, European growth is weaker than the US. But these are not recessionary signals at this point. These are very minor cuts in the forecast for ‘24 and ‘25 by ECB. Although growth is low and the US growth has slowed, I do not see a recession, frankly, in either of these two sets of economies. I think the ECB was right to cut by 25 basis points today and for Christine Lagarde to say that she would be data dependent, will go meeting to meeting, as opposed to giving the market any real outlook for the next several meetings at this point today.
Economists are split over whether the policymakers at the ECB will look to pause when they meet again on October 17, as they had done in July before reducing rates by another quarter point on December 12. The big question is not whether the ECB would cut rates in September, but what is the central bank’s stance on what will follow. Your thoughts on that?
Geoffrey Dennis: The real interest rates in the EU, are lower than they are in the US by over 100 basis points. So in theory, there is less room for the ECB to reduce rates to get to some sort of neutral level than is the case with the Federal Reserve. This is exactly why I understand that the first reaction, the FX market today to the ECB decision, is to push the euro slightly higher.
There is much more scope for interest rates to come down more significantly in the US over the next 12 months than in Europe or perhaps I should say that in the EU, in the euro area and therefore, I would not be surprised if they pause. It is very hard to make a call at this point, because it will depend also on the macroeconomic data. But my guiding principle here is that interest rates in the euro area have got less distance to fall than they do in the US. That will push the dollar lower and that I think means a rate cut in October is, as you say, far from certain, although I am sure we will get one more rate cut before the end of the year.
On the Fed meeting outcome also next week, we are expecting the Fed to cut rates by a quarter percentage point. Are there any chances of an outsized rate cut given the demand and the weak economic concerns?
Geoffrey Dennis: Yes, there is a chance of an outsized rate hike of 50 basis points. But that chance has been significantly reduced, possibly to one in five, by some of the details, of course, of the CPI data earlier in the week. So, for example, the 0.3% increase in core was above consensus, albeit it is not very different from 0.2. But there is still concern about shelter in the headline index and also in the core and the core level itself, although, of course, the headline rate came down sharply to 2.5%. I do not think there is enough here in terms of inflation softening, nor enough weakness in the economy, which I think is doing okay, even though it is slowing to justify an outsized rate reduction.
There will be the fear if the Fed does cut by 50 basis points, so people will say, well, what do they know about the economy that we do not know? So, I think you should expect them to move exactly as the market is suggesting and to move by 25 basis points, probably another two 25 basis point cuts between now and the end of the year. Although, of course, all of this will depend on how the data comes in between now and then.
