At the last meeting. European Central Bank (ECB) cut its key interest rates by 25 basis points despite a small revision to its inflation forecast, it said in its June Bulletin of World Economic Developments. Alfa Bank.
In contrast, the Federal Reserve (Fed) left its policy rate unchanged, mainly due to the steady development of the labor market and the performance of the US economy. It is worth noting that in its 25 years of operation, this is the first time that the ECB has cut interest rates before the Fed and not after (Chart 1).
Sufficient new job growth rates combined with a particularly low unemployment rate (4% in May) are contributing to good economic performance, so with this data, monetary policymakers will be more cautious about cuts; in 2024
Until the two central banks resynchronize during the rate cut phase, there will be a period of temporary desynchronization reflecting the divergence of the deflationary cycle. USA Euro zone (ZtE).
However, this development raises concerns among some analysts that the exchange rate of the euro against the dollar could weaken and therefore increase the prices of imported goods, which could affect inflation and complicate the situation for the ECB, making its policy autonomous. difficult.
However, this concern seems unfounded for now, as the impact of the euro’s devaluation on inflation is likely to be small (Monetary Desynchronization Between The ECB And The Federal Reserve And The Euro, BNP Paribas, June 2024).
According to ECB calculations (Ortega, E. and Osbat, C., 2020. Exchange rate transmission in the euro area and EU countries, ECB Occasional Paper 241, April 2024), a 1% depreciation of the real exchange rate of the euro. increases imported inflation in ZTE by an average of 0.3% and the harmonized index of consumer prices by about 0.04% over the year, which does not prevent inflation from returning to the target. Moreover, it would take a significant depreciation of the euro, which seems unlikely at the moment, for the ECB to change its interest rate policy.
The resurgence of inflationary pressures in the US at the beginning of the year and the persistence of inflation above the Fed’s medium-term target (2%) led markets to expect the Fed to cut interest rates later and more gradually than later. Central banks of G10 countries.
After all, both the post-meeting Fed statement and markets (FedWatch) estimate that there will be one or two cuts in 2024, while a cut is not considered certain before the presidential election in November. in the USA.
The main channel through which policy rate differentials can affect the economic outlook is the “exchange channel”, that is, a reduction in capital flows and demand for foreign exchange in countries where yields are lower, which can lead to depreciation. domestic currency.
As mentioned above, the devaluation would lead to an increase in the prices of imported goods and an increase in inflationary pressures. So far, the inflationary effects in this channel are moderate (Chart 2a).
Only in the exceptional case of significant interest rate differentials is inflation warming in ZtE likely.
As an example, we note that in a recent Goldman Sachs study (Central Bank Divergence: Room to Run?, June 2024), it argues that a 1 percentage point divergence in monetary policy from the Fed would lead to structural growth. Inflation in ZTE is around 0.2% as this will have a downward impact on the EUR/USD exchange rate in the 4%-5% range.
What happened after the Fed said it would keep its key interest rates on hold last week is that the spread between the Fed and the ECB pushed the dollar to a one-month high, while the 2-year and 10-year Annual Treasury yields. The USA has increased.
Undoubtedly, the uncertainty caused by the result of the European elections, mainly in France, also played an important role in the strengthening of the dollar (graph 2b).
What should be noted is that the divergence between ZEE and US monetary policy is expected to be temporary, while the effects on the ZEE economy will be limited.
In the US, inflationary pressures have been more resilient than expected, and although economic activity slowed in the first quarter, US growth rates are significantly higher than in the EU.
Also, the divergence mainly reflects a difference in timing and not a difference in orientation and will have a limited impact on ZtE due to offsetting factors (Monetary and Economic Sovereignty of Europe, Francois Villeroy de Galhau, June 2024).
