WASHINGTON/LONDON-With key central banks now aligned in cutting interest rates, a real-time experiment is underway in how much the global financial landscape has changed since the pandemic and, in particular, whether the easing cycle may be short-lived due to higher underlying rates.
The impact of the Federal Reserve last week joining a process already started at the European Central Bank, the Bank of England, and elsewhere with a larger-than-anticipated half-point rate cut could be extensive—already credited by some analysts for clearing the way for the People's Bank of China to unveil its largest stimulus since the pandemic with fewer concerns about how that might influence local currency values.
But how long and how far the global easing may continue remains unknown as policymakers explore whether the rates required to keep inflation in check and economies growing are higher now than the ultra-low ones common before the pandemic.
Officials in Washington, Frankfurt, and London are skeptical they can specify that "neutral" rate of interest other than by seeing how economic conditions evolve as rates fall, a tricky exercise likely involving instinct and intuition as much as math and modeling.
They agree, however, it is likely higher than before, a conclusion that at some point will cause officials to proceed more cautiously toward further rate cuts.
Referring to the pre-pandemic years, when the Fed's rate hovered near zero for years and Europe delved into the exotic world of negative rates, Fed Chair Jerome Powell said last week he felt that world is gone for good.
"That's so far away now, my own sense is that we're not going back to that," Powell said. "It feels to me that the neutral rate is probably significantly higher than it was back then. How high is it? I just don't think we know... We only know it by its works."
Those "works" would include inflation at the 2 per cent target that the major central banks all share, and an unemployment rate, wage growth, and economic growth all near the potential consistent with that pace of price increases.
Among major central banks, only the Bank of Japan is not easing monetary policy to approach that point, but is tightening after finally succeeding in lifting inflation.
For the Fed, in projections issued last week, the median stopping point for rate cuts seen by officials was 2.9 per cent, to be reached by the end of 2026. But individual projections were spread across a range from 2.4 per cent to as high as 3.9 per cent.— Reuters
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