With the year 2024 about to end, it is time to review the evolution of interest rates, and how the outlook has changed over the last year, and also to review where the price of money in the United States seems to be moving. and the euro zone next year. The rate cuts by the Federal Reserve and the European Central Bank have been concentrated in the second half of this year, and looking to 2025, everything indicates that paths will separate for these two central banks. The Fed has a more turbulent year ahead, with an economy that will not allow aggressive rate cutswhich poses a more uncertain scenario than the one ahead the ECB, a central bank for which continuous rate cuts are expected during the first half of the year.
The roadmap that the markets expect for the two central banks is clear, at least until the macroeconomic forecasts take a turn and force the Fed or the ECB to change gears in the rate cut process. Investors are buying at this time that the ECB will continue with the constant rate of reductionswith four consecutive cuts in the price of money, from January, until the June meeting and another in September, leaving the total cut at 125 points for next year. However, For the Fed, only a rate cut is now priced in all of 2025a movement planned for the month of May.
The scenario that investors expect for the ECB fits perfectly with what analysts are expecting. The market consensus that reflects Bloomberg coincides with the expectations of rate cuts that investors expect, something that, however, does not happen for the Federal Reserve: in its case, investors continue to expect three rate cuts of 25 basis points, two more than they have bought the markets.
The Fed has been forced to revise its forecasts for rate cuts in 2025, as it certified that the economy is not slowing down as much as expected. Activity is holding up well in the world’s leading economy, and unemployment has not deteriorated enough to undertake an aggressive process of cuts in the price of money. If we add to that that Donald Trump, winner of the November presidential elections, brings with him political proposals that threaten to increase inflation again, the cocktail is perfect so that the Fed has to be very calm before starting to lower rates. types aggressively.
“While the Fed does not explicitly incorporate possible policy changes under the new administration, the Fed’s projection of higher inflation next year suggests that they are incorporating a more uncertain inflation scenario,” explains Mahmood Pradhan, head of global macroeconomics at Amundi Investment Institute. “His confirmation that rates will be higher for longer led to a significant market reaction, a much stronger dollar and a rise in Treasury yields,” Pradhan points out.
The inflationas it could not be otherwise, is the key piece in the macroeconomic puzzle that central banks monitorand fear of a new spike has generated the Fed’s reaction. “Markets have been surprised by upward revisions to inflation forecasts. It is now expected to move largely sideways next year, and that remains above 2% until 2027, a year later than previously expected, with important implications for the trajectory of interest rates,” highlights Raphael Olszyna-Marzys, international economist at J. Safra Sarasin Sustainable AM.
The outlook for the ECB could not be more different. The euro zone economy does not show the vigor that the US economy does, and therefore the path of interest rates will be very differentwith continuous cuts until reaching the neutral interest rate, which, for many analysts, remains around 2%. “We continue to believe that the ECB will reduce interest rates by 25 basis points at each meeting, until they reach 2%,” explain Hugo Le Damany and François Cabau, economists at Axa Investment Managers. “We expect inflation prospects to be below the ECB’s target, which will lead it to cut the deposit rate to 1.5%, at the latest by the end of the year,” explain the two experts.
Will the delay in 2024 be repeated?
Although the market seems to be clear that there will be 125 basis points of rate cuts in 2025 in the euro zone, it cannot be ruled out that, what has happened in the first half of 2024, a significant delay in the start of the rate cut , can be repeated next year. So, at the beginning of this year, the market had in mind a path of rate cuts from the first stages of the year, something that, in the end, could not be carried out, due to the strength shown by the economic data.
Although the ECB is in a very different situation to that of the Fed, and Philip Lane, the ECB’s chief economist, is clear that the time has come to lower rates and leave behind restrictive monetary policy, the great danger facing 2025 is the same: in the United States it has already become clear that the inflationary danger has practically erased from the map the possibility of seeing several rate cuts next year, but in Europe, just as happened in 2024, there is the possibility that a stronger inflation what was expected would ruin the scenario of several consecutive rate cuts that the markets are now pricing in.
“Weak growth and persistent inflation make us more cautious with the ECB,” says the Schroders analyst team. “While markets anticipate that rates may fall to 2% by the end of next year, we believe this outlook is too aggressive, and we anticipate that the terminal rate will be 2.5%,” they note.
What seems clear is that, although the Fed is going to have a complicated path to cut rates aggressively, the ECB is going to have a more complex year, in which there are upside and downside risks for inflation, and There is also the possibility that there will be a slowdown in economic growth, and this, added to the continuity of moderate inflation, may lead the central bank to have to change its roadmap of rate cuts, both upwards and downwards. lowers it. In fact, leaving the door open to this possibility is what the ECB intends when it assures that it will maintain its decisions meeting by meeting, and that the economic data that is published will decide the speed and scale of rate changes in the coming months.
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