In a move to stimulate a sluggish economy, the European Central Bank (ECB) has cut interest rates for the third time this year. This decision comes almost a month after the Federal Reserve announced a bold 50 basis point rate cut.
What Happened: The ECB’s latest rate cut marks the first time in 13 years that the bank has made consecutive rate reductions.
The central bank is shifting its focus from battling inflation to encouraging economic growth, which has been trailing behind the United States for the past two years.
In June, Morgan Stanley had predicted that both the ECB and the U.S. Federal Reserve would cut rates in September, citing decelerating inflation in both regions.
Shortly, the ECB reduced interest rates by 25 basis points, signaling a shift in policy to moderate monetary restrictions. This move was anticipated as the ECB assessed the inflation outlook and the effectiveness of monetary policy transmission.
The Fed also followed suit with a 50 basis point rate cut in September, as announced by Jerome Powell, with the probability of further rate cuts in the future drawing differing opinions.
The Analyst: The ECB has not provided specific guidance on future rate changes, emphasizing that decisions will be data-driven and made “meeting by meeting.”
However, as described by economist Mohamed El-Erian in a recent Bloomberg interview, the Federal Reserve is moving away from data dependency and taking a more strategic approach to interest rate cuts.
When asked about the difference in how ECB and Federal Reserve address the rate cuts, El-Erian noted it is partly because different countries within the Eurozone experience inflation differently.
“But I do agree with the notion…the market right now is pricing the same amount of cuts from the ECB and the Fed. And I don’t think that’s gonna happen. I think the ECB will cut more than the Fed,” he added.
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Potential Difficulties: Meanwhile, Joachim Klement, an investment strategist at Panmure Liberum, expressed in an op-ed published in Reuters about concerns over the potential difficulties that the European Central Bank (ECB) and the U.S. Federal Reserve may encounter in managing the escalating national debt amid rate cuts.
The International Monetary Fund (IMF) recently introduced the concept of “fiscal r-star,” the real interest rate needed to maintain stable national debt levels when an economy is growing at potential and inflation is on target.
Based on current consensus projections for eurozone budget deficits and GDP growth, the ECB's policy rate would need to drop to about 2.0% in the next three to five years to stabilize debt levels. The situation is more alarming in the U.S., where the fed funds rate would need to fall below 2.5% to prevent the country's debt-to-GDP ratio from increasing.
Why It Matters: The ECB’s decision to cut rates again comes as part of a broader trend among global central banks.
Economists have earlier suggested that the ECB’s actions could trigger a wave of coordinated rate cuts by central banks worldwide, potentially increasing market volatility in the coming months.
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