This Wednesday the Federal Reserve has confirmed something that has been perceived for several weeks. It has not touched interest rates. It will most likely continue today, with the meeting of the Council of the European Central Bank, where no changes in the price of money are expected. It seems that the upward rate cycle of the last two years has almost definitively closed. Better to add the word almost to the rollercoaster of shocks since 2020 and, in the longer term, since 2008. The central scenario is that the period of restrictive monetary policy is shelved and the market sentiment is that 2024 will witness the first reductions in the price of money, for many, as soon as spring.
What happened in 2023 for this change in expectations? On January 9, I wrote in these same lines that this year had all the earmarks of being a transition year and that it could really be expected that the good news about inflation would become visible in 2024 and 2025. In part, it could have been a transition because despite Of the great intensity and acceleration of applied medicine—rate increases—until summer, not all the effects have been perceived this year. However, recent months have been marked by greater inflationary moderation in Europe and the United States than expected, without, until now, a serious derailment of economic activity and employment. The United States inflation data published on Tuesday continues to point to moderation. We are within the coordinates of a soft landing for economic activity after the strong increases in interest rates.
The economy has slowed down and continues to do so – for example, as shown by the latest data from the leading indicator PMI, Purchasing Managing Index, for the EU – but it seems to be closer to slackness than to a significant drop or collapse in activity. The labor market is holding up reasonably well, something that also has an impact on the strength of consumption. There is nothing to predict that the Christmas campaign will not be in line with last year’s, the first of normality after the pandemic. The lower effective impact of the rise in the price of money on economic activity and employment may delay central banks from considering rate reductions. The statements of the monetary authorities this week confirm this lack of urgency. The markets, however, are already pricing in reductions in spring 2024. Perhaps with some haste. Too early to know what will happen in the next six months.
Caution should reign in the coming months. This is what the presidents of the main central banks have recalled in their latest public statements. Follow the strategy of going meeting by meeting and seeing what the data reveals. It is true that the feared second round effects, which threatened half a year ago especially the United States and the central euro countries (which have presented larger wage increases), do not seem to have materialized. However, this is no guarantee for the future. Of course, the energy markets, especially oil, have behaved in an almost surprising way, especially after the start of the conflict between Israel and Gaza. Everyone held their breath in the first weeks of the war for fear of an escalation that would have multiplied the virulence of the conflict—already devastating in terms of human losses—also on the economic side. Any conflict in the Middle East usually results in an increase in the price of oil, but in this case and to date, this has not been the case. However, central banks will do well to continue monitoring the energy price situation in the coming months, in order to ratify the current trend towards moderation in inflation and feel broadly comfortable with a possible rate reduction that, if the things remain the same, it would occur, not to help the economy, which does not seem to need it urgently, but as a consequence of prices clearly declining. It cannot be forgotten that central banks care more about core inflation, which does not take into account energy or fresh products in its calculation, than the CPI, and although the former has also moderated, it is significantly above the latter. . Likewise, some prices (such as those of certain services) tend to have greater weight in the decisions of monetary authorities. Currently, these prices have moderated less, so they may delay a change in the monetary situation.
In short, we have months to wait until we know if the central banks begin to lower rates. Caution seems to require it, because you don’t want to take unnecessary turns, such as starting to reduce, and then having to raise the price of money again. The moderation of inflation is not necessarily linear or proportional over time and past experience, significant scares cannot be ruled out. Of course, if it were confirmed that the moderation of inflation continues, the process of price growth, whose duration was underestimated at the beginning, would have turned out to be less persistent than what was expected a few months ago. Only in this scenario could a rate reduction be envisioned in 2024. Of course, probably without market emergencies.