In light of recent geopolitical developments, especially in the Red Sea, with significant implications for the global economy and world trade, questions arise about the projected rate cuts for 2024.
Tensions in the Red Sea region could disrupt supply chains, leading to rising commodity prices and rekindling inflation rates. This follows global central banks’ efforts to combat inflation by reducing rates, falling short of their 2 percent target.
The Federal Reserve expresses concern that the Red Sea crisis may further impact inflation. Simultaneously, the Statistical Office of the European Union estimates a half-percentage-point increase in inflation during the first and second quarters of 2024 due to the crisis.
In Europe, the Red Sea crisis dampens hopes for a potential rate cut in the eurozone economy this year. Economists warn that the turmoil poses a new threat to already unstable global supply chains, potentially resulting in higher commodity prices and inflation.
Interest rate cuts, not anytime soon
In 2023, interest rates began to rise as major central banks increased borrowing costs to curb high inflation. However, inflation cooled down in many countries mid-last year, prompting central banks to pause rate hikes. The Fed, having raised its benchmark interest rate 11 times in the preceding two years, indicated at least three rate cuts in 2024 during its first meeting in December.
Subsequent statements by Fed officials suggested that interest rates would not be cut immediately. They emphasized insufficient progress in inflation and cautioned against rushing into a rate cut until it’s evident that inflation will continue to decline.
Initially, financial markets anticipated the first rate cut in March, followed by five more cuts in 2024. However, following various statements, traders now believe that the rate cuts are likely to commence in April rather than in March.
Economists anticipate the path of interest rate cuts to be clearer in June, considering household spending strength and economic uncertainties. The Fed governors seek evidence supporting a faster or broader rate cut, requiring swifter and more sustainable inflation or negative news from the job market. However, such evidence has not yet surfaced.
Read: GCC banks to prove resilient in 2024 amid geo-economic challenges: S&P Global
Assessing the current situation in Europe
The European Central Bank is facing a similar scenario. ECB President Christine Lagarde cautioned, “The risk could be worse if we went too fast and fast and had to come back to more tightening because we would have wasted all the efforts that everybody has put in the last 15 months.”
Lagarde settled the dispute surrounding widely traded speculation in financial markets regarding the ECB’s potential interest rate cut in spring. In the January meeting, the bank opted to maintain the deposit rate at 4 percent for the third consecutive time. Lagarde expressed her intention to avoid premature interest rate cuts, acknowledging the possibility of a rate cut by summer if there are no significant inflationary shocks. Consequently, her stance is that discussing rate cuts at this point is premature.
The ECB’s decision to abstain from setting a specific date for interest rate changes is primarily driven by the need for substantial evidence, mirroring the approach taken by the Fed. The ECB aims to ensure that the high wage growth observed in the eurozone during late spring does not pose a persistent threat to inflation. The current estimated annual wage growth of 5 percent in the eurozone is inconsistent with the ECB’s inflation target of 2 percent.
Act with prudence
Similarly, the International Monetary Fund is cautious about rapid rate cuts. IMF Deputy Managing Director Gita Gopinath has emphasized the need for central banks to act prudently, warning that market expectations for a more flexible monetary policy could trigger another wave of inflation.
Gopinath indicated that inflation is expected to decelerate at a more gradual rate compared to the previous year. This is due to tight labor markets and increased inflation in the services sector across multiple regions, including the U.S., the euro area and elsewhere. These factors contribute to a challenging or “bumpy” trajectory towards achieving lower inflation. Therefore, Gopinath recommends that official interest rates should not be reduced until the second half of the year.
“Based on the data we have seen, we would expect rate cuts to be in the second half, not in the first half,” Gopinath said in an interview with the Financial Times.
The IMF has cautioned against “premature celebrations” by central banks in the past, as they relaxed after an initial decline in inflation, only to see price growth plateau or rise again.
According to one analyst, the specific timing of the rate cut may be uncertain. However, there are clear indications that monetary policymakers are signaling a shift toward more accommodative policy stance. This shift is aimed at preparing the markets for the initiation of rate cuts.
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