Economic moments are often forecast with great certainty, but few will have been as widely expected as an interest rate cut by the US Federal Reserve this week.
Analysts have included a reduction in the cost of borrowing by the US central bank in their forecasts for more than a month and investors have placed their bets accordingly.
The Fed’s chair, Jerome Powell, is likely to be fine-tuning his script before Wednesday’s decision, but there is little doubt the US central bank head’s message will be that the cost of borrowing can fall now that inflation is back within sight of his 2% target, before adding that the likelihood of rapid growth in prices will remain low for a while.
A fall in inflation to 2.5% will allow Powell and the rest of the Fed board to reflect on the state of the US economy and whether it needs any help from lower interest rates. They are expected to decide it does, making it less a case of when to reduce borrowing costs as by how much, from the 5.25-5.5% range that has been in place for the last 14 months.
Economic signals indicate that the next six months will be defined by a lack of momentum. This verdict applies to the economies of the US, China and Europe, including the UK. Each of these large blocs is suffering a slowdown; without extra impetus, the world’s major economies might continue to expand during 2024, but at an agonisingly slow pace. This demands action from central banks, which have considerable room to make cuts after two years when interest rates – the chief weapon used to bring down rocketing inflation – hit heights not seen for decades.
Powell knows that while most US businesses remain robust and the latest jobs data indicates they are still hiring new staff, some bellwether firms such as the tractor maker John Deere and the washing machine manufacturer Whirlpool are shedding staff. Those in work are still struggling with a cost of living crunch that is constraining their spending in a way not seen since the recession that followed the 2008 financial crash.
The situation is less acute in Europe, though the European Central Bank and the Bank of England have already begun cutting rates to prevent a slowdown turning into a recession.
On Thursday, the Bank of England could take UK interest rates down another notch to 4.75% from 5%. But investors are expecting governor Andrew Bailey and his colleagues to remain cautious and wait for more signals that the economy is struggling. Unlike in the US, a0.25-percentage-point cut is not expected until November.
Some analysts say jobs figures in the US show Joe Biden is still presiding over a “goldilocks economy” – neither cooling nor overheating in a way that would panic the Fed.
Dhaval Joshi, chief strategist at BCA Research, says investors are less optimistic when they look beyond 2024 to next year. A full-blown US recession is expected, and interest rate cuts that will be swift and deep. This dire outlook is reflected in the interest rate curve, which tracks speculation by investors on future rate moves; it forecasts borrowing costs going down from 5% now to below 3% in 2025.
Businesses are facing rising operating costs, elevated interest rates and a strong US dollar that restricts exports. Job layoffs, subdued at the moment, could rise.
Nevertheless, Joshi thinks the Fed will limit itself to a quarter-point cut on Thursday and not the half point some say is needed. A half-point cut could spook the market, especially when estimates of economic growth show it running at 2.5%, he said. “People would wonder: what does the Fed know that we don’t?”
At last month’s gathering of central bankers in Jackson Hole, Wyoming, Powell said: “The time has come for policy to adjust.” That much is certain.
The reaction of businesses and investors is less obvious. They might think a modest rate cut has come too late to save them and sell up.
A stock market correction is the kind of new year gift that the incoming US president would want to avoid, but may find is inevitable.
• This article was amended on 18th September 2024 because an earlier version said that the interest rate curve forecasts borrowing costs going “from 5% now to below zero in 2025”. That should have said going to below 3% in 2025.
