Central Bank racing: the ECB in pole position
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Article Type
Insights
Topic
Macro
Published
October 16, 2024
Read time
5 mins
Author
Irina Kurochkina, CFA
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The monetary easing season has officially started in global rates markets. The major central banks responsible for around 90% of reserve currencies have decreased their key borrowing rates at least once in the last few months. With economic growth synchronized in most regions due to global trade flows and interconnected capital markets, central banks tend to follow each other in policy changes. While the US Fed is usually seen as a leading central bank, the current easing cycle is marked by the ECB pioneering monetary policy action.

Usually, when the global economy is under weather, the US Fed is racing to be on the frontlines to start the interest rate-cutting cycle. Given the dominance of the US economy and the size of its financial market, this indeed proves to be an important stimulus for other markets and an important sentiment driver in different asset classes. This time around, the Fed was not the first major central bank to kick off the cutting season. The ECB, which is usually seen as a more cautious follower, cut rates in June by 25bps, while the Fed started easing only in September. The underlying strength of the US economy and higher inflation numbers kept the Fed on hold, while the outlook for the European economy started to lose steam and inflation pressures were waning away.

The new cutting cycle is remarkable because central banks are starting from a very high level, comparable to where rates were before the Financial Crisis of 2007. It may give policymakers more room for deeper cuts if necessary, but it will also add more uncertainty to the rates market by introducing more volatility around pricing the terminal rate.

Due to the lags in monetary policy impact on the real economy, we cannot know in advance if central bankers are making the right call in rate changes. However, the ECB seemed to make a reasonable step by starting their cutting cycle in June and not waiting for the Fed. Despite some components of inflation being still somewhat sticky, the price pressures continued to ease and restrictive rates continued to dampen economic activities in Europe. The Fed had to follow the pack with 50bps cut in September, which seems to be a catch-up move that sent a confusing signal to the market. The ECB, on the other hand, made another 25bps decrease in rates in September and managed to communicate its reaction function more clearly.

Graph: Interest rate changes since end of 1999 till September 2024. Source: Aegon Asset Management, Bank for International Settlements.

Major easing cycles since 2000s:

  1. The dot-com bust in the early 2000s led to the economic recession in the US. The US Fed started cutting rates aggressively, followed by the cuts by the ECB and others to combat the global slowdown.
  2. Global Financial Crisis 2007-2008. The housing market crash in the US spiraled into a full-blown global financial crisis, triggering massive central bank interventions worldwide. The Fed cut rates from 5.25% in 2007 to 0-0.25% by 2008. Similarly, the ECB reduced its rates, and other major central banks like the BOE, and the BOJ followed suit with significant rates curs and unconventional policies such as quantitative easing (QE).
  3. Eurozone Sovereign Debt crisis (2010-2013). European countries such as Greece, Spain, and Italy experienced severe debt crises, leading to fears of defaults and economic collapse in the Eurozone. Given the idiosyncratic nature of the crisis, the ECB took the lead in lowering rates and providing liquidity to the market. Other central banks kept rates low during that period.
  4. Slowdown 2018-2019. This easing was not driven by a recession but by a fear of global economic slowdown and trade tensions (especially between the US and China). Central banks shifted from tightening to easing, with the Fed cutting rates three times in 2019. The ECB restarted its asset purchases, and other central banks either cut rates or maintained ultra-low rates.
  5. Easing started in 2024 after two years of a tight monetary policy. In July 2024, the ECB reduced its key rates by 25bps. In September, they followed with another 25bps move, and the Fed matched it by moving by 50bps in September, and the BOE has cut rates by 25bps.


Time will tell if this cycle is just a “normalization” and central banks will succeed in moving back to neutral rates in the absence of a major economic slowdown. There is still a possibility that this cutting cycle is the beginning of a race to save the economy that was damaged by the extremely quick and steep hikes started in 2022. Mixed signals or lack of clear communication by central banks can damage their credibility in supporting the economy and limiting market volatility. A stable and predictable path of cuts will help the ECB to act in time if there is more weakening in the European economy around the corner. In this central bank racing, the ECB is in a position to deliver on its mandate.

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Author

Irina Kurochkina, CFA
Portfolio Manager

Irina Kurochkina, CFA, is a portfolio manager in the fixed income, LDI and investment solutions team with a focus on sovereigns.

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