The Australian central bank has already put its money where its mouth is by announcing in early June a 25 basis point cut to the official overnight lending rate, which now stands at 1.25%. However, this easing move was unnecessary. For this year, Australia will likely report GDP growth of 2%. At the same time, inflation is well under control. This interest rate manoeuvre is indeed a novelty in economic history and a blueprint for what is to come. It appears that central banks are acting without any sign of acute danger on the horizon. In fact, both the European Central Bank (ECB) and the US Federal Reserve are also preparing to cut interest rates, despite the fact that there is no indication of the kind of economic excesses that would normally cause them to take corrective steps.
Frankly, the eurozone economy is not luxuriating on a bed of roses at present. The international trade disputes are weighing heavily on the export-dependent German economy, and this in turn is having a negative impact on the common currency area. The Italian economy is a “sick man”, and therefore once again slowing the growth momentum in the EU. However, the recession risk has remained manageable until now. The probability of an economic contraction as calculated by VP Bank research currently stands at a mere 23%. So any necessity for monetary easing cannot be inferred from this. Nonetheless, the core inflation rate (i.e. excluding volatile food and energy prices) of 1% is still far away from the ECB’s target rate of 2%. At the same time, inflation expectations have fallen recently and currently also stand at around 1%, entirely too low if you ask ECB monetary policy setters. It follows that an interest rate cut can be rationalised – albeit only with reservations, given the low recession risks. At –0.4%, the overnight deposit rate for commercial banks with the ECB is already in the ultra-expansive range.
Even more astonishing is the tack the US Federal Reserve is taking. The US economy still has a good chance of growing at a 2.5% this year. Moreover, the consumer price index core inflation rate is at a relatively high 2%. Only the personal consumption expenditure (PCE) price deflator ex food and energy is still below the Fed’s target of 2% at 1.5%. So far, there is still no sign that the labour market will face a more pronounced slump: initial applications for unemployment benefits are close to all-time lows.
So by just reading the current economic data, there is no immediate need for an interest rate cut. Be that as it may, the decision makers at the Fed have verbally rolled out the red carpet for even easier money in the coming months.
This rapid and clear move away from the normalisation of central bank policy is indeed a novelty. In the past, it was not rare that central bankers risked even a “hard landing”, i.e. a recession, in order to prevent the economy from overheating. Now it would appear that they are already starting to backpedal at the mere hint of an economic downturn. The ECB stopped buying securities just six months ago, and the Fed raised the target rate last December. One can only guess about the possible reasons for the very abrupt shift into reverse gear.
The following arguments appear plausible:
Interest rate cuts are likely to be on the agenda at both the ECB and the Fed. Presumably, the ECB will announce an easing move as early as July, with concrete measures fol-lowing in September. A further reduction of the deposit rate is conceivable. The Fed could also announce a rate cut in September. The SNB needs to take a watch-and-wait stance in this environment. The rate-setters are paying par-ticular attention to the development of the Swiss franc: if it appreciates, interventions are almost sure to follow. We cannot rule out the possibility of an SNB deposit rate cut, but that is unlikely to be the central bank’s first choice.
Bernd Hartmann, Head CIO Office
Author: Dr Thomas Gitzel, Chief Economist
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