Special Edition

To what extent are rate cuts a good sign?

11/14/2024

The ECB made its first rate cut at the beginning of the summer, followed by the Fed, which lowered rates by 50 basis points. After three cuts of 25 basis points by the ECB,
Hélène Baudchon explores. Is this a good sign or a bad one?

Emmanuel Laborde: So, it's all about rate cuts. This is a topic regularly discussed at the Economic Research Department. This is your field, Hélène.

Hélène Baudchon: Hello.

Emmanuel Laborde: Let's review these rate cuts in the chronological order. What we saw and happened these last months.

The ECB initiated the first cut at the beginning of the summer. Then, the Fed followed. When we're recording this video, we are in the last weeks of 2024, the ECB has made three 25 basis point cuts.

So, we have one question in mind. That's the title of this segment. Is it a good sign or a bad sign?

Hélène Baudchon: It is rather a good sign, for now. Central banks are normalising their monetary policy having driven their key rates to quite high levels to control the surge of inflation. We see well on the chart the huge increase in interest rates. But as inflation has strongly receded these last two years. And the 2% target being attainable, it paves the way for rate cuts in parallel with the decline in inflation. In nominal terms, it means monetary policy is becoming less restrictive.

Emmanuel Laborde: There's also anticipation in these rate cuts.

Hélène Baudchon: Yes. This is also a pro-active approach. The Fed and the ECB are not reacting to a suddenly deteriorating economy but they are acting in a preventive way to preserve the existing situation, that is to say a soft landing of the US economy and a slow economic take-off in the Eurozone.

Emmanuel Laborde: So, after a period of high rates, the rate cuts cycle has started. Now the question is: at what rate will it continue?

Hélène Baudchon: According to our central scenario, We expect the cuts to continue at a gradual and regular pace in the coming quarters. The objective is to continue to support growth avoid growing risks of deterioration. That is particularly true for the Eurozone where signs of recovery are still fragile. The ECB, during its October meeting, said they were monitoring the situation. But this is true also for the US if they want to avoid a sharper labour market slowdown.

Emmanuel Laborde: Let's not forget inflation.

Hélène Baudchon: Central banks have to take inflation into account. It has not totally disappeared. It decreased but it has not disappeared. There are pockets of resistance, in the services sector in particular, where inflation is still high and its decline limited. That is why it is important too not to lower rates too fast.

Emmanuel Laborde: This fine-tuning process to find a balance between growth and inflation, that's the recurring point with interest rates. What's the objective?

To what extent will central banks lower their rates?

Hélène Baudchon: In our baseline scenario, We expect the Fed and the ECB to come near neutral rate, that is to say the theoretical interest rate which neither boosts nor inhibits economic activity. We would still be in a rather positive scenario where we won't need monetary policy to be really accommodative to support economy more strongly.

But if we look at the risks surrounding this central scenario, for the ECB, a stronger monetary easing could be necessary. While that's the opposite risk in the US.

Emmanuel Laborde: Thanks. We will follow this topic in the weeks and months to come.

Let's join our next guest, Laurent Quignon.

THE ECONOMISTS WHO PARTICIPATED IN THIS ARTICLE

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