Central Banks Facing Crucial Interest Rate Round: Differentiated Approaches Needed

The summer in Europe was not only hot for tourists but also for central bankers on both sides of the Atlantic. Under pressure from political quarters, financial markets, and public opinion, they face the task of carefully weighing future interest rate policies. For central banks, this proves to be a universal challenge, regardless of the current economic conditions or prevailing key interest rates. At the core of the discussion are different arguments: While inflation steadily approaches the 2 percent target, core inflation remains stubborn. Recession fears persist, although current data do not indicate an alarming trend; the U.S. economy continues to create new jobs, and in the Eurozone, economic expectations, according to a survey by the European Commission, are near their long-term average. A sudden stock market crash in the first week of August initially caused unrest but ultimately proved to be temporary, as the U.S. stock index S&P 500 surged significantly in the following month. Nonetheless, many continue to demand a rate cut amidst these conflicting signals. With the upcoming September meetings in view, central banks should thoroughly reconsider their decisions. It is particularly significant to recognize that they are not all in the same starting position. There is much in favor of an interest rate cut for the U.S. Federal Reserve. With the key rate reaching a 23-year high of 5.25 to 5.5 percent, it stands about 3 percentage points above the Fed's preferred inflation measure. A moderate cut of 0.25 percentage points would send an encouraging signal while maintaining the necessary restrictive stance to complete the disinflation process. According to Fed Chair Jay Powell, "the direction is clear," as he emphasized in his speech in Jackson Hole in August. The Bank of England is similar to the Fed in many respects. Inflation is somewhat closer to the 2 percent target but could rise again. The decision to cut the key rate before the summer break was already controversial and was made against the objections of Chief Economist Huw Pill. Currently, there is less urgent need for action than in July and less than for the Fed. The European Central Bank is in a completely different situation. Not only did it cut rates before the holidays, but its key rates, at 3.75 percent, are also significantly lower than the Fed's. This is due to historical reasons linked to the negative interest rate policy from 2014 to 2019. Given the current situation, the ECB has less room for further easing. The latest inflation rate in the Eurozone, with a decline to 2.2 percent in August, belies the unchanged core inflation of 2.8 percent. The drop was mainly due to falling energy prices and is not a conclusive argument for immediate action. Philip Lane, Chief Economist of the ECB, emphasized that the inflation target is not yet secured. To achieve further progress, it is necessary to maintain the current real interest rate level of about 1.5 percent. Christine Lagarde, President of the ECB, has repeatedly pointed out that the ECB follows its own course and does not trail the Fed. The upcoming meeting in September provides an opportunity to prove this.