BoC and ECB lead the way in rate cuts

Earlier this month, the Bank of Canada (BoC) took another step towards normalising its monetary policy by reducing its key interest rate to 4.25%. This marked the third consecutive rate cut of 25 basis points in 2024.

Following the BoC's lead, the European Central Bank (ECB) also announced a rate cut this week. The ECB also lowered its key rates by 25 basis points, bringing the deposit facility rate to 3.50%, the main refinancing operations to 3.65% and the marginal lending facility to 3.90%. This marks the second rate reduction in 2024 in the EuroZone.

As these major central banks decided to keep loosing their monetary policies in September, investors and traders are closely watching for signs of similar actions from other central banks around the globe. The upcoming weeks will be crucial in determining whether the current trend of rate cuts will continue or whether central banks will adopt a more cautious approach, as the Fed and the BoJ are meeting.

BoC and ECB signal economic weakness

In its latest monetary policy meeting, the BoC expressed concerns about a potential economic slowdown. While the economy grew at an annualised rate of 2.1% in the second quarter of 2024, exceeding the bank’s expectations of a GDP of 1.5%, recent data suggests that growth may be weakening.

Indicators point to softer economic activity in June and July, and the labour market, previously a strong point, shows signs of deceleration with stagnating employment growth. Despite earlier optimism and the BoC's July prediction of a 2.8% annualised growth rate in the third quarter of 2024, these emerging challenges pose downside risks to Canada's economic outlook for the latter half of the year.

The ECB is also adopting a more cautious outlook due to weaker-than-expected economic growth in the Eurozone. Initially, the Eurozone's economy grew by 0.3% in the first quarter of 2024 compared to the last quarter of 2023, with the same figure reported for the second quarter 2024. However, Eurostat later revised the second quarter's growth estimate down to 0.2%.

In response to this, the ECB has revised its growth forecast for the second half of 2024 downward with lower levels than previously predicted, prompting the ECB to lower its overall growth forecast for 2024 from 0.9% to 0.8%. Growth is however still projected to improve slightly in the coming years, with forecasts of 1.3% in 2025 and 1.5% in 2026.

ECB Chair Christine Lagarde emphasised that while the recovery is expected to gain strength over time, supported by rising real incomes, the risks to the Eurozone growth “remain tilted to the downside:. Potential threats include weaker global demand and lower demand for exports from the area, escalating trade tensions, and ongoing geopolitical risks such as Russia's war in Ukraine and the conflict in the Middle East. These factors could undermine business and consumer confidence and disrupt global trade.

Additionally, if the lagged effects of the ECB's monetary policy tightening prove stronger than anticipated, growth could be further constrained. On the other hand, Lagarde also stresses that growth could surpass expectations if inflation declines more rapidly than expected, boosting consumer confidence and spending, or if the global economy performs better than currently forecasted.

The Fed is expected to cut interest rates for the first time since June 2019

The Federal Reserve (Fed) is poised to make a significant policy shift as it prepares to lower interest rates for the first time since June 2019. This highly anticipated move has investors and analysts closely watching for clues about the central bank's intentions.

The declining average rate on 30-year fixed mortgages, falling from 6.35% to 6.2% this week according to Freddie Mac data, is a clear indication of market expectations for a rate cut. As investors and potential homebuyers anticipate a more accommodative monetary policy, mortgage rates have begun to adjust.

While a rate cut is widely expected, there remains considerable debate within the financial community about its magnitude. Some analysts believe the Fed will opt for a more aggressive half-point reduction, while others predict a more modest quarter-point cut.

The CME Group's FedWatch Tool reveals a notable shift in market sentiment. As of September 13th, the probability of a rate cut to the 5-5.25% range has decreased to 55% from 72% just a day earlier. Conversely, the odds of a larger cut to the 4.75-5% range have risen to 43% from 28%.

Top Federal Reserve officials have been vocal in their support for a series of interest rate cuts, citing signs of easing inflation and concerns about the potential economic damage of maintaining high borrowing costs.

Although the Fed has not expressed major concerns about the overall U.S. economy, it has acknowledged rising downside risks that could warrant more aggressive easing. Additionally, while inflation has been moderating, there are still underlying inflationary pressures, particularly in housing and services.

Futures markets are anticipating a significant reduction in interest rates by the end of 2024, potentially including a half-point cut at one of the remaining meetings. Credit agency Fitch Ratings has forecast a cumulative 250 basis points of reductions spread over 10 moves across 25 months.

With the Fed's decision just days away, investors and analysts are eagerly awaiting to see how the central bank will balance the need to support economic growth with the goal of maintaining price stability. The first rate cut since 2019 has the potential to significantly impact financial markets and the broader economy.

Other central banks’ meeting

The Bank of England (BoE) has lowered its key interest rate to 5% from its 16-year high. While the central bank acknowledged the need for continued restrictive monetary policy to combat inflation, it also signaled a potential shift towards a less aggressive stance.

Investors will be closely watching the BoE's upcoming meeting in September for clues about future interest rate decisions and the pace of its bond sales, a politically charged issue that has garnered significant attention.

The Bank of Japan (BoJ) surprised markets in July by raising interest rates for the first time in over a decade. While a rate hike is not expected at the upcoming policy meeting, a majority of economists predict a gradual increase by the end of the year. The BoJ is expected to proceed cautiously, raising rates approximately once every six months to assess the impact on the domestic economy.