Throughout the summer, there has been rampant conjecture regarding the possibility of transatlantic central banks reducing their interest rates within the remainder of this year. The key questions relate to the projected pace and timeframe of these rollbacks. With inflation data now paving the way for such cuts, the European Central Bank and the US Federal Reserve should not delay in executing these actions. Even after such reduction, borrowing costs will indeed stay constrained. Currently, there’s an increased risk associated with maintaining excessively high interest rates for an extended period.
Recent statistics reveal that the inflation rate in the Eurozone declined to 2.2% in August, a drop from July’s 2.6%. This is close to the ECB’s 2% target. However, the services sector’s inflation continues to be high at 4.2%, which could be due to France’s Olympic-related data. The ECB had earlier slashed their rates in June and according to forecasts, we can expect another reduction of a quarter point in their principal deposit rate next week when their central council convenes for policy-making. More conservative council members have underscored the need for sustained evidence of inflation reduction before endorsing further cuts. Contrarily, there’s concern about the likelihood of a long-term situation of “chronically below-target inflation”, as articulated by ECB’s chief economist, Philip Lane. This term refers to a similar situation following the financial crisis.
Financial markets, therefore, anticipate that the ECB will effect the cut in September, possibly followed by another one or two cuts within this year. Similarly, the Fed’s chair, Jay Powell, also clearly anticipates the first reduction in key interest rate in four years to occur within this month. Recently released data shows that one of the preferred measures of inflation by the Fed remained static at 2.5% in July.
Predicting the decision of the central bank is not an exact science. Unavoidable delays in the rollout of interest rate adjustments and the time it takes for them to make a significant impact resist any precise projection. Nevertheless, the current accumulation of risks suggests that it is appropriate to initiate cuts now, thereby providing some relief to borrowers.