Will Central Banks Be Forced to Go Faster?

We know the Federal Reserve wants interest rates back to 3% because that's the level it considers optimal for the economy - neither too low nor too high.

Chair Jerome Powell has been quite clear that he is not pleased with any more decline in the US job market.

First, is there an absolute need to lower rates quickly and faster? Despite recent economic fears, the most current figures are in order. While developed-world job markets are cooling to varied degrees, the classic increase in layoffs often following a recession has yet to materialise.

Can we get any peace of mind? Maybe not.

In the US, we know that official employment figures are exaggerating the situation. Since the non-farm payrolls are likely to be lowered nonetheless, Powell admitted this week that he mentally revises them down every month.

According to a compilation of company anecdotes, the economy is showing signs of weakness across the board. Furthermore, the neutral interest rate is a mystery that no one can say for sure at this moment. A majority of central bankers openly admit this.

Given the current state of interest rates, it is arguable that a 50 basis point reduction will not bring you any closer to that neutral level. However, the confidence with which to state so diminishes as rates continue to fall.

But here's the thing: central banks won't be that concerned. In any case, lawmakers' motivations are changing fast. The 1980s horrors are over.

The attention is quickly shifting to preserving the gentle landing. Would it make a difference if they slightly exceeded the actual neutral rate by a few percentage points while keeping the recovery intact?

Thirdly, central banks are concerned that large-scale cutbacks will lead to more large-scale cuts when pricing them in. The worst-case scenario is that investors think the central bank has insider knowledge.

Curiously, neither happened due to the Fed's 50 basis point drop last week. The takeaway was that the authorities should have made the reduction in July and are now playing catch-up.

Not all investors are on board, but that was also true before the meeting. The markets are considering pricing 75 basis points of US rate reduction by year-end.

In conclusion, large rate cuts by central banks are extremely rare and only implemented in times of extreme crises.

It's not all black and white, though, as the Fed demonstrated last week. We also didn't see it in the most recent trekking round.

Just to refresh your memory, the Fed implemented four 75 bps rate cuts in the span of six months.

The truth is that the economy feels the effects of new policies later on than in the past. Many businesses and households have taken advantage of the historically low interest rates that were available before the COVID-19 pandemic.

From its low in 2021, the Fed Funds Rate increased by almost 5%. While this is true, the average interest rate that people are paying on their existing mortgages has increased by just 0.5% during the same time frame.

Source: Macrobond, ING calculationsThis chart shows the average rate paid on the outstanding stock of mortgages. This shouldn't be confused with current mortgage rates being offered by banks on new lending.

In the past, central banks could achieve rapid outcomes by reducing interest rates in tiny increments. Those days are over. Perhaps more crucial now are the rates' levels and the duration of their stays.

Following a cautious path of 25bp adjustments might appear like an unpleasant compromise if central banks have determined that a rate decrease is warranted.

BRN is concerned that the cautious stance on interest rate decreases may not be sustainable.

Although it is not the base scenario, BRN does not rule out the possibility of another 50 basis point rate drop by the Fed this year.

The European Central Bank and the Bank of England are the same. BRN anticipates that the ECB and BoE will increase the pace of cuts this winter.

The fight against inflation has won, and authorities should take action soon to preserve the economic recovery.

Elsewhere

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