Walter Bibikow
Europe is hardly seen as a leader in the global economy, but this week the European Central Bank made its first decisive move in transitioning away from monetary tightening. The European Central Bank cut its benchmark deposit rate by 0.25 percentage points to 3.75%, the first rate cut in five years. Neither the Fed nor the Bank of England are expected to cut their top interest rates in the near future, and the ECB is the only major central bank to have cut rates so far. But questions remain about whether this is the start of a trend or just a blip.
Hawkish cuts
The rate cut was not a surprise: European Central Bank President Christine Lagarde and her colleagues had all but predicted it since the bank last met. Earlier this spring, the ECB was due to cut rates for the second time. Lagarde and others have been fairly cautious and tight-lipped about future cuts. Bundesbank President Joachim Nagel has warned that the ECB is “not operating on autopilot” when it comes to future cuts. Nagel and other typically conservative central bank governors, such as those of Latvia and Estonia, have warned that the fight against inflation is broadly moving in the right direction but is far from over. Recent strength in the eurozone economy, including better-than-expected hourly wage growth announced today, suggests there is no imminent need to start cutting rates aggressively. The ECB’s own inflation forecast for 2024 rose to 2.8% from 2.7%. Before Thursday’s meeting, futures markets had put the probability of a second rate cut by September at 70%, but the likelihood is now at 56%.
Growth at the Limit
But is the European economy that strong? Among the data trickling out on Friday morning was a weaker-than-expected decline in industrial production by 0.1% in Germany, the EU’s largest economy. Recently, the eurozone has been teetering on the edge of growth and recession, recovering slightly in the first quarter of this year from a contraction in the fourth quarter of 2023. The region’s core economic model, which is heavily dependent on manufacturing and exports, has not changed much. High-value exporters like Germany have been hurt by continued weakness in China, one of their main export destinations. In key global growth areas such as artificial intelligence and cloud computing, Europe still lags far behind the United States and Asian countries such as China, Taiwan and South Korea. One of the main reasons for the chronic underperformance of European stocks is the relative lack of business leaders in these high-growth sectors. We have covered this subject extensively in our commentary.
Next up is Jay
Next up is the Fed. The Federal Open Market Committee meets next week, followed by a packed post-meeting statement, press conference, and the ever-popular “dot plot” next Wednesday. There’s likely to be no major drama here, as the chances of a Fed rate cut are slim to none. As I’ve noted in recent comments, there are plenty of signs of a slowdown in consumer spending, but there are also offsetting data points. The BLS employment report, released on Friday morning, showed a much higher rate of employment growth than expected, with employment increasing by 272,000 (the unemployment rate rose slightly to 4.0%, but this is more due to an increase in the number of people actively looking for work than any meaningful reversal in labor market strength). There is a growing chorus of economists arguing that the Fed should begin cutting rates sooner rather than later, to prevent a soft landing from turning into negative growth. But for now, it’s unlikely that the Fed will show any signs of deviating from its recent mantra of “higher rates for longer.” Thursday’s ECB rate cut is likely to be the only one until the end of the summer.
Editor’s note: The summary bullet points for this article were selected by Seeking Alpha editors.
