Advertisement
Banking & finance
OpinionComment
Marcella Chow
Marcella Chow

Macroscope | Despite Fed pause, interest rates in the US and Europe are likely to stay higher for longer

  • In their latest moves, the ECB raised rates while the Fed chose to pause, but both central banks remain focused on taming inflation
  • A US recession could still be triggered by a too-aggressive Fed or fresh regional bank turmoil

Reading Time:3 minutes
Why you can trust SCMP
Federal Reserve Board chairman Jerome Powell speaks at a news conference in Washington on June 14. The Fed paused its aggressive campaign of interest rate increases despite “elevated” inflation, while indicating a sharp rise could be needed before the end of the year. Photo: AFP
Marcella Chow

As economies reopened post Covid-19, the main responsibility of the US Federal Reserve and European Central Bank (ECB) was to be laser-focused on cooling inflation against the strong economic backdrop. In the past year, both central banks have been driving like racing cars, with the Fed revving up interest rates by 5 percentage points since March last year, while the ECB, having started its engine a bit later, in July 2022, has raised its rates by about 4 percentage points.

Advertisement

The racetrack this year has become more challenging. Both central banks need to balance their monetary policies between still-sticky inflation, a greater risk of recession and financial-sector shocks.

In its meeting last week, the US Federal Open Market Committee voted to leave the federal funds rate unchanged at 5-5.25 per cent. This is the Fed’s first “braking” after 10 straight increases, including four back-to-back increases of 0.75 percentage points each last year.
Advertisement
While this pause had been telegraphed by Fed officials, the statement language and press conference commentary were decisively hawkish, suggesting there may be at least one more data-driven policy rate increase to get the inflation-taming job done. The announcements also conveyed to the market that the Fed has no intention of cutting rates this year, even though it expects them to fall next year and after, which could be divided into four drops of 0.25 percentage points each for 2024 and five of the same in 2025.

But further tightening may be too aggressive given that US headline inflation is coming down and there are growing signs the economy is decelerating. In particular, this month’s inflation rate should soften further compared to the high base last year, driven by slowing rent rises and used car prices. Thus, a policy mistake, leading to a deeper-than-expected recession, could be a key risk.

Advertisement
Advertisement