The Federal Reserve’s sharp interest rate cut this week and its determination to act quickly are a game changer for central banks elsewhere.
In Europe and other developed countries – where officials are accustomed, officially, to minimizing the impact of American decisions on their own monetary policies – people are undoubtedly taking comfort from the analysis made on Wednesday by Fed Chairman Jerome Powell, who reaffirms the good health of the American economy.
In emerging markets, the Fed’s half-percentage-point rate cut helps ease pressure on exchange rates, which had pushed the cost of borrowing in U.S. dollars to its highest level in decades. These countries can then recalibrate their own interest rates, as Indonesia did with a surprise cut just before the Fed.
By cutting rates more than the market expected, the Fed ran the risk of unnerving the public by sending a message that the risk of recession was rising. But Mr. Powell was reassuring, saying that the Fed’s patience, which had so far held steady, had paid off. His remarks appeared to cement the perception that the worst inflation surge since the 1980s has been brought under control.
Wednesday’s decision is “a sign of [l’]”commitment” from the central bank not to wait too long, he said. The stock market reacted favorably at the time, but closed slightly lower.
The Fed’s half-point cut will ripple through other central banks’ decisions and lead markets to conclude that the U.S. economy is slowing, which could lead to a global slowdown.
Stefan Gerlach, chief economist at EFG Bank in Zurich and former deputy governor of the Central Bank of Ireland
According to a recent study by the Institute of International Finance, rate changes in the United States have been the main driver of decisions in Europe since 2021.
“Even if the ECB takes its decisions independently of the Fed, interest rate differentials vis-à-vis the Fed can have real economic effects in the euro area and must therefore be taken into account,” explains Marcello Estevao, chief economist at the IFI. Otherwise, it would risk an appreciation of the euro, a decline in exports, a weakening of the economy and a disinflationary shock.
Already two drops in Europe
The European Central Bank (ECB) could consider another rate cut in October, for the third time since June, an option that “it has steadfastly sought to deny,” Gerlach added. It will also put the Swiss National Bank in an “extremely uncomfortable” position, as it is already concerned about the strength of the franc.
ECB policymakers, led by President Christine Lagarde, have repeatedly stressed that they set rates independently. Before the first rate cut in June, when the U.S. economy was still booming, Mme Lagarde had insisted that the decision would be driven by data, not the Fed.
PHOTO MICHAEL PROBST, ASSOCIATED PRESS
European Central Bank building (right), Frankfurt, Germany
But the ECB also acknowledges that U.S. monetary policy has important implications for the 20-nation bloc. It has not ruled out lowering borrowing costs in October, although that is unlikely, people familiar with the matter said last week.
By acting in October and again in December, the ECB and the Fed would be on the same page about the depth of rate cuts this year. U.S. policymakers expect borrowing costs to be 100 basis points lower by the end of the year than they were before Wednesday’s half-point cut.
According to a recent study by the Institute of International Finance, rate changes in the United States have been the main driver of decisions in Europe since 2021.
World Overview
Central banks in emerging countries, including those in the Persian Gulf, whose currencies are pegged to the dollar, followed suit and also cut rates by half a percentage point. The Hong Kong Monetary Authority did the same.
The Bank of England held its current rate steady on Thursday. The South African Reserve Bank is expected to cut its rate by a quarter point.
The reaction of emerging countries with floating currencies is less predictable.
They have often mirrored the Fed’s moves in the past, but that’s not quite the case in the current cycle, according to Bloomberg Economics. “This desynchronization supports our expectation that emerging economies will, on balance, cut less than the Fed over the next year,” wrote Adriana Dupita and Alex Isakov of Bloomberg Economics in a note.
Indonesia’s central bank rushed to cut its benchmark interest rate by a quarter point on Wednesday, and the U.S. rate cut gives monetary authorities from Seoul to Mumbai some breathing room, although other factors, such as financial stability, must be considered.
In Japan, where the central bank is only just beginning to tighten policy, the Fed’s decision could have an impact on what happens next.
The Bank of Japan is expected to hold its benchmark interest rate steady on Friday. But the updated October forecast could show higher wage and price trends and lead to a quarter-point hike, said Taro Kimura, BE’s chief Japan economist. Unless she interprets the Fed’s decision as a harbinger of trouble for the global economy.