Fed rate outlook: Moving pre-emptively
The US Federal Reserve (Fed) kicked off its rate normalisation cycle with a larger-than-expected 50bps rate cut, acknowledging that the need for restrictive monetary policy has diminished. Fed Chair Jerome Powell made an effort to dispel the impression that the Federal Open Market Committee (FOMC) had decided in favour of the bold cut because of a weak economy or because the Fed has fallen behind the curve.
The updated summary of economic projections is consistent with a rate reduction that targets a neutral policy stance, as expectations of gross domestic product growth have been toned down slightly to a solid 2%, the unemployment rate forecast has been increased to a still moderate 4.4%, and inflation is expected to decline slightly faster and reach 2% in the medium term. Currently, the US economy is quite strong, with a number of GDP nowcasts pointing to 3% growth in the current quarter. At the same time, monetary policy has been in quite restrictive territory for more than a year and remains so even after the 50bps rate reduction, which brought the federal funds target range to 4.75%–5%.
High estimates of a neutral policy rate are around 4%, and a majority of the FOMC members has moved it gradually up to around 3% currently. We think that a policy rate of around 3.5% is neutral, in line with the financial market expectations derived from interest rate swaps. With this backdrop, we assess the Fed’s jumbo rate cut as a pre-emptive move to avoid a too sharp slowdown of economic activity and an acknowledgement that inflation has slowed enough to adopt a less re strictive policy stance. We expect a series of rate cuts to bring the policy rate to our estimate of a neutral level by mid-2025. The front-loaded nature of the rate reduction increases the probability for a soft landing of the US economy.
Swiss National Bank: Towards a neutral monetary policy
The return of inflation to the 0%–2% range that the SNB de fined as price stability in mid-2023 enabled the SNB to reduce its restrictive monetary policy earlier than its peers. At its last two quarterly meetings in March and June 2024, it lowered the policy rate by a total of 50bps to currently 1.25%. Since the meeting in June, inflation has continued to ease, and at 1.2%, the average inflation in July and August was below the SNB’s conditional inflation forecast of 1.5% for Q3 2024. In contrast, economic growth surprised positively, with the Swiss economy growing at an above-average rate of 0.7% q/q in Q2 2024. Accelerating net exports were behind the strong growth, while domestic demand stagnated. Exports eased again in July and August, which is likely partly related to the strengthening of the Swiss franc, which has appreciated around 4% against the US dollar and about 0.7% against the euro since the end of June.
In light of this, we expect the SNB to follow through with a third and final 25bps rate cut at its September meeting, bringing the policy rate to 1.0%, which we believe is the SNB’s estimated neutral level. The US Federal Reserve’s larger 50bps cut last week has fuelled speculation that the SNB could also surprise with a larger rate cut. Markets are currently pricing in a 30% chance of a 50bps rate cut by the SNB this week, as well as a lower Swiss policy rate of 0.50% by March 2025. Given a slowing but robust economy and inflation well within the range of price stability, we expect the SNB to keep its policy rate at neutral levels, leaving room for a more expansionary policy should the growth and inflation outlook deteriorate significantly. In the case of a strong appreciation of the Swiss franc (which is not our baseline assumption), we would expect the SNB to intervene again with foreign currency purchases in foreign exchange markets.
Bank of England: In no hurry to cut rates
In contrast to the US Fed’s outsized 50bps rate cut, the BoE opted to hold its policy rate at 5.00%. Despite having initiated monetary policy easing with a 25bps cut at its August meeting, the BoE appears to prefer a more gradual approach to easing.
In its statement, the central bank pushed back against a faster pace, reiterating that monetary policy must remain restrictive to further reduce the risk of inflation’s sustainable return to the 2% target. Indeed, the consumer price index (CPI) data for August showed headline inflation aligning with expectations at 2.2% y/y but core inflation edging up to an elevated 3.6% and services prices (a key gauge for domestic inflationary pressures) also higher at 5.6%.
Although the pickup in services prices will likely remain temporary and dis inflation will likely continue, the BoE remains cautious about lingering inflationary risks in an environment of high wage growth and a resilient economic rebound. Despite manufacturing remaining a weak spot and growth losing some steam in the summer months, confidence about a continuation of the services-driven rebound after stagnation in the last year remains high. This will likely release some pent-up demand from high rates and political uncertainties.
All factors considered, the BoE can afford a more gradual approach to policy easing. We expect the next cut at the 7 November meeting, followed by a hold in December. In 2025, we expect a pickup in the pace of policy easing, when services inflation has subsided further, with five more cuts, thereby lowering the policy bank rate to 3.5%. This would result in the BoE maintaining the highest policy rate among G10 economies by the end of this year, underpinning our optimistic short-term view on the pound sterling, which we project will reach EUR/GBP 0.83 over the 3-month horizon.