Markets reduce rate cut expectations for 2025

For anyone hoping for steep interest rate cuts, December’s central bank meetings were a disappointment. First, the ECB cut its policy rates by 25bp as largely expected, although some market participants had bet on a 50bp cut. A week later, the Federal Reserve cut the policy target range by 25bp accompanied by a clearly hawkish message. Apparently, policymakers put a lot of emphasis on the upside inflation risks stemming from the incoming US administration and their planned economic policies. Moreover, as marketbased short-term inflation expectations have increased since the US election both in the US and in the euro area, it is clear investors consider the risks global, not only local.

The change in monetary policy outlook led to a repricing in the rate markets. Before the FOMC meeting, markets were pricing in almost three rate cuts by the Fed for 2025. Currently, it expects less than two. Similarly, before the ECB meeting, the central bank was priced to cut rates at least five times in 2025. Now, markets lean towards four cuts only. We think markets overestimate inflation risks, and underestimate risks to growth. The renewed market focus on inflationary risks largely builds on investor speculations around Trump’s future economic policies. But even if campaign promises are held, implementation of e.g. tariffs may not be as easy nor as fast as many expect, or their inflationary impact may not be significant.

Hence, we are still less concerned of a prolonged period of elevated inflation, and more concerned about growth continuing to surprise to the downside. The German economy remains in dire straits, a persistent headwind for euro area. European recovery would also benefit from a pickup in Chinese demand, but that in turn hinges on further fiscal stimulus by local authorities. The US economy remains relatively robust, and surprises have been on the positive side lately, but growth is likely to slow. For one thing, slowing immigration flow is one more negative risk to growth. We keep our call that the ECB will cut rates in every meeting until September, bringing the deposit rate to 1.5%. We revised our Fed call to reflect the hawkish views of the Committee members, and now expect quarterly cuts instead of cuts in every meeting, but we still expect them to land at 3.00% by March 2026

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