Rate Cut: Is the ECB Likely to Move Sooner than the Fed?

Central bank policy decisions may be a major focus for traders worldwide in 2024, particularly regarding the timing of potential interest rate cuts. With the Swiss National Bank's (SNB) March rate cut, all eyes are now on the European Central Bank (ECB) and the Federal Reserve (Fed) to see who might follow suit. Let’s take a closer look:

ECB Members Are Increasingly Dovish

Recent comments from key ECB members hint at a potentially dovish shift in their monetary policy. In simple terms, a dovish stance prioritises stimulating economic Growth Domestic Product (GDP) and employment, which can be achieved through various tools, such as lowering rates or keeping them low.

Yesterday, on Monday, May 27th, two key ECB members, Olli Rehn and Philip Lane, signalled a high probability of a rate cut at the upcoming ECB meeting on Thursday, June 6th, raising speculation among traders and analysts about the future direction of the Eurozone’s monetary policy.

Speaking at the 2024 BOJ-IMES Conference on Price Dynamics and Monetary Policy Challenges, organised by the Institute for Monetary and Economic Studies at the Bank of Japan (BoJ), the Governor of the Bank of Finland, Olli Rehn, explained that the increase in interest rates since July 2022 has allowed the ECB to dampen demand, thereby constraining inflation. 

He noted that headline and underlying inflation, currently at 2.4% and 2.7% respectively, are expected to reach the ECB’s 2% target next year. Rehn believes that the recent downward evolution of inflation seems to be sustainable, which means that it might be time to ease monetary policy in the ECB’s next meeting on June 6th. 

Even though Rehn supports the idea of a rate cut, he also highlights that rate cuts can only occur if this “disinflationary process” doesn’t face “further setbacks” such as increasing geopolitical tensions or energy price hikes.

The other hint about the ECB’s next potential move being a rate cut came from the ECB's chief economist Philip Lane, who declared in the Financial Times that "barring major surprises, at this point in time there is enough in what we see to remove the top level of restriction.”

Still, Lane recognises the need for the ECB to remain in restrictive territory in 2024 to avoid inflation going back up and remaining above the 2% target longer than expected.

Fed Signals an Extended Period of Higher Interest Rates

In recent weeks, Fed officials have reiterated that it may take longer than previously expected for the tightened US monetary policy to sustainably lower inflation to around the  2% target. This suggests that the US central bank might need to maintain interest rates at their current levels for an extended period, embodying a "high for longer" rate environment.

As this lack of progress towards lower inflation is likely to support the idea that the Fed might not cut rates any time soon (some market participants anticipate the first cut from the Fed next September), the ECB is likely to be the first to cut rates if it were to vote for lower interest rates in its next meeting.

Some analysts warn, however, that a significant difference (divergence) in interest rate policy between the Fed and the ECB could weaken the euro (depreciate) due to sentiment shifts in the Forex market. This, in turn, could push up inflation in the Eurozone by making imports more expensive.

Given the inherent uncertainties of the future and the potential influence of unforeseen factors, these scenarios should only be viewed as some analysts' projections, not guarantees. (Source: Financial Times)

Conclusion

Olli Rehn and Philip Lane’s sentiment seem to echo other members of the European Central Bank’s Governing Council that a June rate cut is on the table. This could mean that the ECB is likely to cut its interest rates before the Fed, which is usually the one leading the way when it comes to monetary policy decisions.

Traders should, however, remember that both central banks are relying on a data-dependent approach, which means that the economic data published between monetary policy meetings can have an impact on their analysis, forecast and decision.

Moreover, on Friday, May 31st, a key inflation data report for the Fed will be published: the core Personal Consumption Expenditures (PCE), which might provide more clues about the inflation trend in the US after a set of mixed inflation data published in recent weeks.