At a glance:

  • US Economic Growth and Inflation: The US economy is experiencing strong growth, accompanied by a pickup in inflation, prompting investors to reconsider expectations for interest rate cuts later in the year.
  • Divergent Monetary Policies: Historically, the Federal Reserve has acted earlier and more swiftly in cutting interest rates compared to the European Central Bank (ECB) during economic downturns, with the ECB typically following the Fed’s lead.
  • Potential Role Reversal: There’s speculation that in 2024, the ECB might take the lead in cutting interest rates ahead of the Fed, driven by contained growth and inflation expectations in Europe. This scenario would mark a departure from the norm, as the ECB hasn’t led in any easing cycle since 2000.
  • Impact on Currency and Inflation: If the ECB does indeed lead with interest rate reductions while the Fed remains firm or even increases rates, the euro could depreciate against the US dollar. This would benefit European exporters but could also heighten inflationary pressures due to increased costs of imported goods. However, it’s suggested that central banks may not be prepared to initiate rate cuts at this time.

With the US economy growing strongly and inflation picking up again, investors are starting to reprice their expectations for interest rate cuts later this year. In previous cycles, the Fed only began lowering interest rates once economic growth slowed sharply and recession approached. The ECB would then follow the lead of its US counterpart. We are not there yet today. For example, during the technology bust in 2001, the Fed started cutting rates in January 2001. The ECB followed four months later. In the run-up to the financial crisis in 2008, the Fed started cutting rates in September 2007. The ECB raised rates in July 2008 and then started cutting in October 2008. Historically, the Fed has always acted earlier and faster than the ECB in their interest rate-cutting cycles.

Now in Europe, growth and inflation expectations are contained, raising the prospect of the ECB taking the lead in cutting interest rates in 2024 for the first time, ahead of the Fed. The ECB hasn’t led the Fed in any easing cycle since 2000. Should the ECB lead with interest rate reductions in the coming months while the Federal Reserve holds firm, or even increases rates, the euro will likely decline in value versus the US dollar. A weaker euro would give a welcome boost to the region’s exporters but also increase inflationary pressures across the region as imported goods become more expensive. Most likely, the ECB will wait for the Fed to lead once again. We do not believe that central banks are ready yet to begin lowering interest rates.