Reducing Eurozone rates would bring benefits and risks | Business News

If, as expected, the European Central Bank (ECB) cuts its main policy rate on Thursday, it will be an extremely significant moment.

At a very basic level, the cut – the ECB is expected to reduce its deposit rate from 4% to 3.75% – is expected to benefit millions of families and businesses across the eurozone who have never known interest rate this value since the birth of the single currency, 25 years ago.

British tourists venturing to the usual summer hotspots should also benefit, although it is fair to say that currency markets have been betting on a reduction in rates for some time now. The pound has risen 1.5% against the euro since mid-April.

But the move will also be more significant in terms of what it says about central banks around the world.

At the beginning of the year, US The Federal Reserve was expected to be the first major central bank to cut interest rates.

This would have maintained a tradition that had existed more or less since World War II, in which the Fed always tended to cut rates before its global peers. The tradition ended when, in 2011, the ECB cut interest rates in response to the eurozone sovereign debt crisis, while the Fed kept its main policy rate, the Fed Funds, unchanged.

There was a further break with tradition when, in 2013, the ECB began cutting interest rates again, while the Fed kept them unchanged.

However, these were not normal times. Therefore, this week’s action will be the first in relatively normal circumstances since before the war, in which the ECB (or the Bundesbank, Europe’s most important central bank before the European Monetary Union) made cuts to the Fed.

It’s important to note at this point that the ECB is far from the only central bank whose monetary policy diverges from that of the Fed. The Swiss National Bank and the Riksbank, Sweden’s central bank, have already cut interest rates this year, and at the moment When this article was written, the Bank of Canada was also expected to cut interest rates later on Wednesday.

The Bank of England is also expected to start cutting interest rates in August, while the Fed, on the contrary, is not expected to start cutting before the last three months of the year.

As well as breaking the long-term trend towards normal economic times, it is also worth noting that a rate cut by the ECB this week would be doubly unusual as inflation in the eurozone remains comfortably above the target rate 2% from the bank. It will be a rate cut resulting from concerns about weaknesses in the eurozone economy.

And divergence in the Federal Reserve’s monetary policy does not come without risks for the ECB.

In particular, there will be concerns about what an early ECB rate cut will mean for the euro-US dollar exchange rate. All else being equal, it should weaken the single currency, making the price of eurozone exports to the US more competitive.

However, this carries risks, particularly in terms of increasing the cost of imports – especially energy, which is priced in dollars, which, in turn, could increase inflation. A weaker euro would also carry risks in an election year in the US in which both Joe Biden, the president, and Donald Trump, his opponent, will seek to outdo each other with protectionist policies.

As Mohamed El-Erian, an advisor to Allianz and Gramercy and one of the world’s most experienced investors, wrote in the Financial Times last week: “Too large and persistent divergence in rates risks weakening European currencies beyond the point where that possible competitive advantages offset the costs of higher imported inflation.

“In a US election year, this could also fuel protectionist tendencies that are already about to intensify. The two together would risk financial instability that would spread to amplify economic concerns.”

For this reason, most market observers do not expect this divergence in monetary policy to last too long.

Bruce Kasman, head of global economic research at investment banking giant JP Morgan, recently told clients in a webcast: “The general point is that if we look to 2024…[there are] limited opportunities for easing by central banks – there simply isn’t enough in terms of declining inflation to really argue that central banks can act aggressively.

“There is an opportunity for divergence, but the overall message is that in a world where growth is globally resilient and inflation is still falling, but at a rate that doesn’t really get us back… to something where central banks are quite comfortable with this, it’s leaving you with relatively limited room for general easing.”

That view is shared by strategists at BlackRock, the world’s largest asset manager, who told clients in a note this week: “Falling inflation and 18 months of weak economic activity justify the ECB starting to cut rates. I think it will cut far and fast.

“Similarly, in the US, we only see one or two cuts from the Fed this year. This is not a typical rate cut cycle.

“Investors may see opportunities in more policy divergence, but we think this will be temporary as both central banks will end up keeping rates high for longer.”

So the message for households and businesses in the eurozone is this: although their borrowing costs are about to come down, they may not come down as much as they would like.

This also applies to Brits hitting the sunbeds in Spain, Greece and elsewhere this summer. Enjoy boosting your holiday pound while you can.