Investors and economists are anticipating major central banks to start reducing interest rates in 2024 amid declining inflation, signaling control over prices.
The Federal Reserve, European Central Bank (ECB) and Bank of England (BoE) halted their tightening programs in the latter half of 2023 following aggressive interest rate hikes at the beginning of the year.
As headline inflation rates decrease across significant parts of the G7 industrialized nations and economic growth slows, there's mounting pressure on policymakers to lower borrowing costs.
In the U.S., a decline in price growth during November resulted in the six-month annualized rate of core personal consumption expenditure inflation, excluding energy and food, dropping to 1.9 percent. This figure sits slightly below the central bank's designated 2.0 percent inflation target.
“Policy is now quite restrictive, meaning central banks can loosen without [it] necessarily becoming supportive [of growth]. Think of it as pressing less hard on the brake rather than pushing on the accelerator,” said Neil Shearing, group chief economist at UK-based Capital Economics.
Although these central banks are forecast to cut rates, multiple factors can change these decisions.
Increased inflation risks due to geopolitical tensions, reshoring, more relaxed fiscal policies, and potential enhancements in productivity driven by technologies like AI are factors that could potentially disrupt market forecasts in 2024.
Central banks face the risk of boosting growth and asset prices while potentially reigniting inflation by permitting financial conditions to loosen.
This explains why the ECB and BoE have adopted a more hawkish stance compared to Powell, as they believe it's premature to ease the battle against inflation.
Rate predictions
The Fed kept its key interest rate unchanged for the third time on December 13 at its last Federal Open Market Committee (FOMC) meeting in 2023.
The committee members projected at least 3.75 percent rate cuts in 2024, with investors expecting the initial cut in March. Investors believe there will be five cuts instead of three this year.
“The inflation dynamics certainly allow, and indeed warrant, a rate cut as early as March 2024,” said Tomasz Wieladek, an economist at investment manager T Rowe Price.
According to Reuters, money market pricing forecasts indicate that despite these efforts, the rate is expected to reach approximately 3.0 percent only by the close of 2026, eventually climbing back to around 3.5 percent later on. This figure is higher than the expectations of FOMC members.
This is in stark contrast to what happened after the global financial crisis. Back then, interest rates stayed close to zero for most of the decade, then slowly went up to 2.25-2.50 percent by 2018.
In 2025, the committee's "dot plot" anticipates four more cuts totaling a full percentage point. Three additional reductions in 2026 could potentially lower the fed funds rate to around 2.0-2.25 percent, aligning closely with the long-term outlook, although there's notable variability in estimates for the final two years.
The ECB and BoE are also anticipated to lower rates six times this year, with a Financial Times survey revealing that most economists expect the ECB to begin cutting rates in the second quarter of 2024. Only two predict a move in the first three months of the year. Meanwhile, the BoE is projected to follow suit in May.
ECB rates are expected to reach around 2.0 percent by the end of 2026, down from the current 4 percent. However, this decrease doesn't indicate a return to the unconventional practice of negative rates experienced from 2014 to 2022.
Despite the market's optimism, two prominent ECB members, Bundesbank President Joachim Nagel and Dutch counterpart Klaas Knot, cautioned traders against anticipating immediate rate cuts.
They stressed the need for the ECB to take more time before confirming victory over historically high inflation and reversing the euro's record streak of rate hikes.