Interest rate calls from ECB and Fed to highlight Atlantic growth divergence
Markets will have a busy week of parsing central bank speak, with interest rate decisions from both the US Federal Reserve and the European Central Bank (ECB).
The decisions will highlight the differing economic outlooks on either side of the Atlantic, with the ECB set to reduce borrowing costs for a fifth time while the Fed will leave rates on hold.
The Federal Open Market Committee (FOMC) reduced rates by 25 basis points in December, signalling that there would be just two rate cuts in 2025.
But investors have dialled back their expectations for interest rate cuts in the US over recent weeks, even though there has continued to be progress on inflation.
This is due to fears about the potential inflationary impact of Donald Trump’s economic policies and the continued resilience of the US economy.
“We expect the strength of the economy and uncertainty over immigration and trade policy to prompt the Fed to pause its easing cycle,” Bradley Saunders, north America economist at Capital Economics said.
Figures out the day after the Fed’s meeting are expected to show that the US economy grew at an annualised rate of 2.7 per cent in the fourth quarter.
Given this combination, most traders expect just one cut and some even think there is a chance that the Fed could lift rates again in the coming months.
Chair Jerome Powell will likely face a lot of questions in the press conference about the outlook for rates, particularly given President Trump’s insistence that interest rates should be lower.
Analysts at BNP Paribas said Powell would also face questions about the “tail risk of rate hikes”.
“We expect him to reply cautiously by indicating they are less likely, but could come into view if needed to secure a soft landing for inflation and growth,” they said.
All of this is in stark contrast to the economic outlook for the ECB. Carsten Brzeski, global head of macro at ING, said a rate cut was a “no-brainer” given the weak growth outlook.
The ECB cut rates four times during 2024, bringing the benchmark interest rate down to three per cent, but Brzeski said this was still too high.
“The deposit interest rate is still restrictive and too restrictive for the eurozone economy’s current weak state,” he said.
Figures due on Thursday are expected to show that the economy grew just 0.1 per cent in the fourth quarter, significantly weaker than the US.
The latest forecasts from the IMF suggest that the US will grow 1.9 per cent next year while the euro area will grow 1.0 per cent.
With the growth outlook so weak, tIntraders anticipate four or five rate cuts from the ECB this year, even though there are some signs of building inflationary pressures.
“The balance of macroeconomic risks seems to have shifted from concerns about high inflation to concerns about low growth,” Konstantin Veit, Portfolio Manager at PIMCO said.