This week marks a crucial turning point for global monetary policy, with attention firmly fixed on the United States, where the Federal Reserve is expected to cut interest rates for the first time since early 2020. While the Bank of England is unlikely to make any changes, financial markets are anticipating a more aggressive move by the Fed to stave off an economic downturn. Speculation over the size of the US rate cut has already sent ripples through the markets, hinting at broader economic consequences.
The Federal Reserve has kept its target interest rate range between 5.25% and 5.5% since July 2023. However, the recent signs of a slowing US economy have intensified recession fears, leading market participants to question whether the central bank will opt for a modest 0.25 percentage point cut or a more significant 0.5 percentage point reduction. The larger cut, gaining momentum in market predictions, would signal the Fed’s commitment to protecting the economy from further deterioration while addressing inflation concerns.
Meanwhile, the Bank of England’s approach appears more conservative. Following a quarter-point cut in August, there is little expectation of further reductions when the bank meets later this week. Despite some weakening in the UK economy, inflation continues to weigh heavily on policymakers’ decisions, particularly core inflation, which excludes volatile items like food and energy. A Reuters poll suggests that consumer price inflation will remain flat at 2.2% for the year to August. Wage growth remains strong, reinforcing the view that there is no immediate need for further easing. Market sentiment reflects a low probability—around 30%—that the Bank of England will introduce another rate cut this year.
The contrasting strategies of the Federal Reserve and the Bank of England highlight the distinct economic challenges each nation faces. In the US, the economy, though showing signs of softening, remains underpinned by a robust labour market. However, inflation continues to present challenges, leaving the Federal Reserve in a delicate position of needing to support growth without allowing inflationary pressures to re-emerge. In the UK, economic growth has been weaker, but persistent inflation remains the primary concern for the Bank of England, prompting a cautious approach to further cuts.
The anticipation of a rate cut in the US has already had an impact on financial markets. Early this week, the US dollar saw a slight decline, dropping by more than a third of a cent against the British pound to $1.31. At the same time, oil prices, which often react to changes in US interest rate expectations, rose in response to speculation of a more accommodative monetary policy. A larger-than-expected rate cut by the Fed could trigger further market shifts, reflecting broader confidence that the central bank is committed to reviving economic momentum.
Economists like Michael Feroli of JPMorgan are advocating for a 50-basis-point cut, citing the Taylor Rule, which suggests that current Fed policy may be too restrictive by at least one percentage point. Feroli argues that such a move is essential to prevent the US economy from slipping into a deeper slowdown while bringing inflation closer to the central bank’s 2% target.
Susannah Streeter, head of money and markets at Hargreaves Lansdown, echoed this sentiment, noting that while there is a divide in market expectations, even a smaller rate cut would signal the beginning of a broader easing cycle. This could include up to 100 basis points of cuts by the end of the year, as the Fed works to prevent the economy from stagnating. With inflation heading towards target and demand slowing, the Fed is likely to initiate a series of cuts aimed at stimulating growth and keeping the economy from reversing course.
The decisions made by the Federal Reserve and the Bank of England this week will have far-reaching implications, shaping the direction of global markets as central banks strive to balance inflation control with economic stability. Investors are watching closely, aware that the upcoming policy shifts could significantly influence currency, commodity, and broader investment trends in the coming months.
(Source: Skynews)