ECB: Disinflationary forces on the rise
The ECB is increasingly confronted with the reality of stagnating economic progress, in which a loss of price competitiveness, rising foreign competition, tight fiscal policies, and heightened political and trade uncertainty make a restrictive monetary stance inappropriate. The general tone of ECB policymakers seems to acknowledge these developments, with recent comments on the economy and the monetary policy outlook adopting a predominantly dovish tone, preferring an interest rate policy that is more accommodative to stimulate spending in this economy.
The dovish tone of ECB officials, as well as negative surprises in economic data, is contributing to increased confidence that the ECB will cut interest rates this week. While the economic fundamentals support even a bold 50bps cut, we believe the bar is extremely high for the ECB to cut rates by 50bps in one meeting and that it will prefer to cut rates by 25bps instead and continue at that pace at upcoming meetings. The eurozone is struggling with a significant loss of international price competitiveness, as labour costs and factory prices have risen more than in other countries over the past three years. This means lower wages and job uncertainty will create disinflationary forces in the coming months, making the current restrictive monetary stance misplaced. We expect the ECB to revise its economic projections accordingly, lowering its growth and inflation forecasts for 2025 and 2026.
The Fed faces far fewer deflationary forces
On the other side, the Fed has fewer deflation concerns, and officials are showing a hawkish tone, favouring higher interest rates to keep inflation in check, so a rate-cut pause is plausible. The analysis of Fed officials’ comments points to a predominantly hawkish sentiment, making a pause in the rate-cutting adventure at the next Federal Open Market Committee meeting far from implausible. President-elect Trump’s policy agenda adds to the Fed’s caution on rate cuts. Given mixed economic data, the timing of further Fed rate cuts remains highly uncertain.
SNB outlook: Gradual rate cuts closer too zero
Since the SNB’s last meeting in September, inflation in Switzerland has continued to fall, with the October and November readings coming in below the SNB’s conditional inflation forecast for the fourth quarter of 2024. In November, monthly price momentum declined for a third month in a row, and the rise in prices for domestic goods and services, which has been the main driver of inflation in Switzerland over this year, continued to weaken.
In particular, the rent component, which accounts for around 20% of the consumer price index (CPI) basket and has been a key driver of inflation this year, started to ease in November. The contribution of rents to CPI inflation is likely to fall further next year, as existing rents are linked to the mortgage reference rate, which is unlikely to rise any further in 2025 but may even fall given the SNB’s rate cuts. Falling electricity prices in 2025 are likely to lead to a negative inflation contribution from the energy component next year. At the same time, we do not expect any significant upward pressure on other components of the CPI basket that would offset the moderating contributions from rent and energy and push up overall consumer price inflation.
Therefore, we have lowered our inflation forecast for 2025 to 0.4% from 0.8% previously. The ongoing disinflationary forces in Switzerland and a lack of catalysts for stronger upward pressure on prices should prompt the SNB to cut interest rates further. We have added an additional rate cut to our SNB outlook and now expect a total of three upcoming 25bps rate cuts – one on 12 December 2024 and two more in March and June of next year – bringing the policy rate to 0.25% by June 2025.
What does this mean for investors?
Central bankers are challenged given the major divergences they are observing in the global economy. The Fed, albeit tempted, will hopefully resist postponing the rate cut next week and front-load the remaining rate cuts. All the more so, cutting would be a pre-emptive move ahead of the political changes that are looming as of Inauguration Day in the US on 20 January 2025. As for Europe, the ECB is asleep at the wheel, as the fundamentals call for heavy policy action, unlike in the US. This will likely put a lot of pressure on the SNB, since its safe-haven status will trigger further capital inflows as investors miss a sense of urgency at the ECB. We have added another SNB rate cut for next year and have upgraded our CHF forecast accordingly.