Can UK, US cut interest rates on lines of Europe?

On Thursday, the European Central Bank (ECB) announced its first interest rate reduction in five years, lowering its main interest rate from a peak of 4% to 3.75%. This decision followed a similar move by Canada a day earlier and mirrored actions taken in recent months by nations such as Sweden, Switzerland, Brazil, and Mexico. After significantly raising borrowing costs in recent years to control rising prices, countries globally are now changing their approach.

In contrast, officials in the UK and the US, where borrowing costs are currently at their highest levels in years, are anticipated to refrain from rate cuts in their upcoming meetings this month. However, many analysts predict that action may be taken later in the summer or early autumn, asserting that it is only a matter of time.

These developments signal a new phase in the global fight against inflation, which surged during the pandemic. Economists are hopeful that inflation is finally being brought under control in some of the world’s largest and hardest-hit economies. “It’s an important move,” said Brian Coulton, chief economist at Fitch Ratings. “We’re moving into another stage.”

Just a few years ago, central banks worldwide were raising interest rates aggressively to curb economic activity and alleviate inflationary pressures. This coordinated effort was a response to global supply chain disruptions and shocks to food and energy markets that drove up prices. However, this coordination has diminished over the past year and has become more varied.

In Europe, the UK, and the US—regions that had not faced significant inflation for decades—officials have been maintaining rates at high levels. The ECB’s recent decision reflects confidence that inflation trends are improving, according to Emma Wall, head of investment research and analysis at Hargreaves Lansdown. “What the central bank is saying today is, although it might not be coming down in a straight line, they are confident they can get inflation back down to the 2% target level,” she explained.

Inflation in Europe currently stands at 2.6%, down from a peak of over 11% in late 2022. In the UK, it has decreased to 2.3%, and in the US, the Federal Reserve’s preferred measure, the personal consumption expenditures index, has fallen to 2.7%. Despite these improvements, the Federal Reserve remains cautious, wary of potential setbacks due to stronger-than-expected growth and substantial government spending.

“The eurozone economy is in a different place than the US,” said Yael Selfin, chief economist at KPMG. Many forecasters expect at least one rate cut in the US, Europe, and the UK this year, with more likely in 2025. These cuts would benefit businesses and households seeking loans, but analysts caution that the reduction in rates will likely be slower and more cautious than the previous hikes.

Central banks face a delicate balance: raising rates too quickly could spur economic activity and drive prices up again, while moving too slowly could prolong economic hardship due to high borrowing costs. In announcing its rate cut, the ECB avoided making promises about future actions. “The statement arguably gave less guidance than might have been expected on what comes next,” noted Mark Wall, chief economist at Deutsche Bank. “This is not a central bank in a rush to ease policy.”

In Europe, pre-pandemic factors such as slower growth and an aging population may eventually push rates back toward zero, according to Joseph Gagnon, senior fellow at the Peterson Institute for International Economics. However, he believes the US will not return to the ultra-low borrowing costs seen after the financial crisis, partly due to large budget deficits that will likely keep rates higher. “We will be a little slower than Europe to cut, but I think we’re also going to end up at a higher interest rate when this is all over,” he said.

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