What’s on central bankers' minds heading into the summer?

Each year, summer is bookended by two landmark central banking conferences where central bankers, academics and a few members of the private financial sector congregate to discuss new research of interest for monetary policy and compare notes on the outlook: in late June, the ECB Forum held in the windy coastal town of Sintra, Portugal; and in late August in the scenic Rocky Mountains valley of Jackson Hole, Wyoming. This year, the Sintra winds were blustery and relentless, but the discussions as calm, focused and insightful as ever, an apt metaphor for central bankers’ condition these days. Some key takeaways.

No hint of triumphalism despite soft landings basically achieved

The leading central banks are reaching or closing in on their inflation targets, with labour markets in robust health. All saw themselves “in a good position”, but none was ready to declare mission accomplished. They are concerned about hazards lurking down the runway.

For the US Federal Reserve (Fed), the key one is the risk of a flare-up in domestic prices because of the tariffs imposed by the White House on all US trade partners. In Sintra, Fed Chair Powell acknowledged the FOMC would likely have cut interest rates already were it not for that risk. So far, there has hardly been any sign of passthrough from tariffs to prices, but firms had non-tariffed inventories to run through and could afford to wait for clarity on the final level of tariffs. This is likely to change over the next few months. How large will the passthrough be and to what extent will it lead to generalized increases in prices and wages are the key questions, with the answer depending in large part on GDP growth. Hence a very non-committal Powell on the next steps, seeing “multiple paths from here”. We foresee no cut before the autumn or even later.

Like the Fed, the Bank of England (BoE) has yet to fully bring inflation back to 2% and hence is keeping monetary policy restrictive, having eased very gradually thus far; but, unlike the Fed, it is facing the prospect of a rapidly deteriorating employment outlook that made Governor Bailey confident to state that the direction of travel for rates is clearly down. We expect a cut in August.

For the European Central Bank (ECB) and the Bank of Japan (BoJ), on the other hand, the predominant concern is a persistently too low inflation. This may seem paradoxical: headline inflation has been running at basically 2%
for 2 months in the Eurozone, and well above this target for 3 years running in Japan. But both are concerned about the outcome of tariff negotiations with the US and its impact on domestic and global growth. Japan, in addition, is facing near term political uncertainty, while the ECB has to contend with a fast appreciation of the euro against the dollar (by 14% year-to-date).

All these create disinflationary risks, as does a resumption of the downward trend for energy prices. As such, the ECB saw it as appropriate to hold in a neutral stance for now, and the BOJ in an accommodative one. We expect another 25bps cut from the ECB in September, while it may take longer for the BoJ to feel confident enough that underlying inflation will settle at 2% to take another step toward normalization (i.e., a rate hike).

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