Fed Is Pivotal For When And Whether ECB And BOE Cut Rates
Authored by Simon White, Bloomberg macro strategist,
Money markets are scaling back interest-rate cuts priced in for the ECB and the BOE in the wake of Wednesday’s higher-than-expected CPI print in the US. Historically, it is rare for either central bank to ease ahead of the Federal Reserve, and this time may be no different.
More often than not market analysis takes the insider view. Experts in ECB or BOE language-parsing will make predictions about their rate paths, but neglect the importance of the outsider view – namely that the Fed is often pivotal in each bank’s decisions.
The market still sees it more likely the ECB will cut ahead of the Fed, but those odds have come down after the US CPI data. Last week a rate reduction that was seen as near certain at June’s ECB meeting is now only 80% expected. The change in BOE expectations has been larger, with the odds halving to 40% for a cut in June. This all comes as the probability the Fed cuts in that month has dropped to only 20%.
The outsider view would lean towards the ECB and BOE not cutting rates in June. The risk-reward for taking this view is still favorable in Europe. The chart below shows the Fed and ECB’s (Bundesbank for pre-1999) policy rates back to the 1970s. The vertical blue bars show the times when the ECB has cut rates after a six-month pause, and the Fed has not on net cut within the previous six months.
As we can see there are only three occasions when the ECB has cut ahead of the Fed in the modern era, and these were all when Europe was in a negative-rate regime.
The other three times when the then Bundesbank cut first were in the 1970s, after the 1987 crash, and during the recession caused by German reunification in the 1990s.
It’s also rare for the BOE to jump the gun on rate cuts, with only three instances over the last 50 years.
Inflation’s evolution will be key. Fixing swaps show that traders have added a net positive change to their expectations for the next 12 months of CPI prints in the US. Europe and the UK are heading in the same direction.
The dollar’s jump on Wednesday only intensifies inflation pressures for Europe and the UK. The euro and sterling are lower, and cutting rates first would strengthen this unwelcome trend.