The Strategist

USA and Europe: Central banks on separate paths

Against the backdrop of gradually declining inflation rates in the world's two largest economies, central banks are facing important monetary policy decisions. While financial markets expect monetary policy to ease next year, with four to five rate cuts by the Federal Reserve (Fed) and the European Central Bank (ECB), we see a more nuanced picture.

Date
Author
Roman Neupert, Research and Strategy, LGT Private Banking
Reading time
10 minutes

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Our analysis highlights the different starting positions of the two institutions. Against this backdrop, we think three to four rate cuts by the Fed and five by the ECB are plausible over the course of 2024. Below we discuss the complex reasoning behind this prediction and highlight the different paths that the two central banks are likely to take.

US economy defies interest rates: stable growth and robust labour market

The picture in the United States is one of persistent inflation, robust economic strength and a stable labour market. Driven by the Federal Reserve's expansionary monetary policy, catch-up effects from supply chain disruptions and government stimulus in response to the corona pandemic, the inflation rate peaked at 9.1% in mid-2022. Although it has declined steadily since then, it has remained above the 2% target since mid-2023, at over 3%.

At the same time, the US economy grew surprisingly strongly, with GDP rising by an annualised 3.3% in the fourth quarter of 2023, exceeding many analysts' expectations. Despite high interest rates, growth of 2.5% was recorded for 2023 as a whole. By comparison, the eurozone economy recorded significantly weaker growth of 0.5% in 2023. According to the figures, US growth was broadly supported by household consumption, exports, government spending and business investment.

The robust economy is being underpinned in particular by strong labour market data. The unemployment rate remained at 3.7% in January - signalling full employment - which was better than many analysts had expected. The robust labour market should therefore lead to continued wage growth and contribute to general price increases.

The current data do not suggest that the US is slipping into a recession. On the contrary, the risk that inflationary pressures will persist is likely to increase. As a result, the Federal Reserve is in no hurry to cut interest rates and will likely continue to pursue a restrictive policy to prevent inflation from rising again by aiming for a gradual slowdown in economic growth - a soft landing. Given the favourable starting position and low risk of recession, we expect only three to four interest rate cuts by the end of 2024.

Eurozone struggles: inflation meets weak growth

On the other side of the Atlantic, the picture is different. Inflation in the eurozone continued to ease at the beginning of the year - consumer price inflation was 2.8% year-on-year in January - and is far from its record high of 10.7% in autumn 2022. But in contrast to the US, the eurozone economy has performed worse than expected, with disappointing growth of 0.5% in 2023. Germany, the currency area's largest economy, proved to be a brake on growth, contracting by 0.3%. The growth outlook for the eurozone is also gloomy, with the European Commission forecasting slight growth of 0.8% in 2024. These prospects will likely force the ECB to cut rates sooner. We expect five rate cuts in 2024, one or two more than by the Fed.

2024 remains an uncertain year for monetary policy

The current economic developments and monetary policy challenges in the US and Europe make for an uncertain year ahead. While the US has a robust economic performance and a solid labour market, which should allow for cautious monetary policy easing, Europe faces the challenge of overcoming weak growth and persistent inflationary pressures. The divergent monetary policy stances of the Federal Reserve and the European Central Bank not only reflect different economic realities, but also underscore the need for a careful balance between fighting inflation and managing growth.

 

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