The European Central Bank is expected to cut interest rates this week: a key watershed moment for global monetary policy is coming!

Finance Associated Press

2024-06-03 09:24Published on the official account of Cailianshe under Shanghai Poster Industry Group

Finance Associated Press, June 3 (edited by Xiaoxiang) As we reported last month, as the Federal Reserve does not move, and the Asian Central Bank does not dare to move, in this week's wave of interest rate cuts by the world's major central banks, European central banks are likely to rush to the front line without hesitation, and this week, this heralds that the "watershed moment" of global monetary policy is undoubtedly coming:

The European Central Bank is expected to announce a 25 basis point rate cut at its interest rate meeting on Thursday, and market expectations for this are almost full......

Many industry insiders said that the ECB could open the door to a weaker euro at that time, as its first rate cut in the current cycle puts the region on a policy path that is not at the same pace as the Fed. With Thursday's 25 basis point rate cut almost a foregone conclusion, officials will finally accept the widening of the difference in borrowing costs on both sides of the Atlantic, which they have been discussing for months.

ECB policymakers, led by ECB President Christine Lagarde, have recently insisted that they can go their own terms with the Fed, even if doing so could lead to a weaker local currency, which could lead to a recurrence of inflation.

At its April meeting, the ECB showed greater confidence that inflation is on track to reach its target and opened the door to a rate cut at the upcoming June meeting. Since then, a series of comments from ECB policymakers have also highlighted their intention to cut interest rates, with Lagarde having said on several occasions recently that a rate cut in June is "highly likely".

Looking at the pricing of interest rate swap markets, market traders are now pricing in a 97% probability of a rate cut by the ECB this week.

With a rate cut almost certain, the ECB's view of the second half of the year will undoubtedly be the focus of many market participants this week. One will be closely watching the ECB's monetary policy statement and any forward guidance from Lagarde at the press conference for a glimpse into the path of future rate cuts. The ECB's upcoming meeting will also provide updated economic projections on economic growth and inflation, which will be scrutinized for clues of future policy intentions.

For now, ECB policymakers are likely to still emphasize their data-dependent stance in order to wait for more clues from upcoming economic data releases and wait to see when the Fed is likely to make its first interest rate adjustment, according to industry sources.

In his latest speech on Friday, Bank of Italy Governor Fabio Panetta acknowledged that cutting borrowing costs poses exchange rate risks to prices, but added that US tightening would also hurt global demand, thereby helping to tame inflation in the eurozone.

Data released on Friday unexpectedly rose to 2.6% year-on-year in May from 2.6% in the Eurozone, highlighting the uncertainty that the ECB still faces in achieving its goal of full price control. Investors now widely expect the ECB to cut interest rates at least once this year after June.

A watershed moment for global monetary policy has arrived

In any case, the most immediate global macro impact of the ECB's interest rate cut this week is undoubtedly a clear indication that a watershed moment in monetary policy has been fully realized, and the divergence of interest rate policy in developed countries is taking place in a form that was considered highly unlikely just a few months ago.

In addition to the ECB, the Bank of Canada is also expected to announce a rate cut on Wednesday, and the Danish Bank is likely to take the same rate cut as the ECB a few hours after the ECB's decision. In fact, the global divergence in policy rates has already begun, as European central banks such as the Czech Republic, Hungary, Sweden and Switzerland cut interest rates earlier this year.

Back in early 2024, markets had expected the Fed to lead the rate-cutting cycle early this year – a cycle they had thought would spread cautiously to other advanced economies. But now, the market is predicting that the Fed will cut rates only once this year (instead of the six or seven times expected at the beginning of the year), and that European central banks will cut rates earlier and more sharply than the Fed.

This could further amplify the policy divergence between them and the Fed: the ECB's previous rate hike cycle started later than the Fed and ended up raising rates by less than the Fed's 525 basis points.

At present, all these policy divergences and interest rate differentials can foresee several direct implications: the dollar's global interest rate differential advantage may become more pronounced in the future, which may further maintain the dollar's strong position this summer. More and more global central banks are joining the army of interest rate cuts, which may give the overall market a certain boost to risk appetite. However, it is difficult to say what exactly this means for global markets in the long term.

Mohamed El-Erian, Allianz's chief economic adviser, wrote over the weekend that the question may ultimately lie in the potential scope and extent of this policy divergence between Europe and the United States, and how this will affect the coordination between countries' domestic economic priorities and avoiding adverse exchange rate fluctuations.

According to Yerian, too large and persistent interest rate divergence could weaken the euro to the point where the competitive advantage that a currency depreciation could provide would not be able to compensate for the costs of higher imported inflation. In an election year, it could also fuel protectionist tendencies in the United States, which are already on the verge of intensifying. Combined, the two could create the risk of financial instability, which in turn would amplify concerns about the economy.

However, Yerian also said that it is difficult for the policy rate differential between Europe and the United States to widen by more than 50-100 basis points in the short term. Whether such interest rate differentials are in fact sufficient to meet Europe's domestic policy priorities remains an uncertain question. But one thing is certain: the "key" to narrowing this divergence in the future will be in the hands of the Fed.

Erian noted that except in times of severe crisis, the Fed has been keen to emphasize that its policy decisions are only based on considerations of domestic circumstances; So we should not expect the Fed to change its approach just because of the policy dilemma Europe may face. But for Europe now, the Fed has also recognized that over-reliance on data and strict adherence to the 2% inflation target could unnecessarily increase the likelihood of a hard landing for the US economy; And if such a hard landing occurs, the already struggling poor families and small businesses will be the most miserable, and the impact will be particularly hard and long-lasting.

"Eventually, the Fed will adjust but not count on something, and what can be expected is that Europe will see the limits of interest rate divergence by the end of the year," Elian said. ”

(Finance Associated Press Xiaoxiang)