Different outlook

Western central banks are planning differently for 2024

Last week saw the major central banks of the Western world essentially indicate that they were on different paths with regard to monetary policy. Neither the United States Federal Reserve (Fed), nor the European Central Bank (ECB), nor the Bank of England changed interest rates. But they nevertheless have very different views of their actions and the economy. The big news was that the US Fed announced a pivot, reversing a series of interest-rate increases that had been the steepest in decades. The markets galloped in response, and some worried that they were building in a possible interest-rate cut as early as March. Fed officials hastened to say it was too soon to say when a cut was coming, but the damage was done: They had already indicated likely cuts next year, constraining their room for manoeuvre. The Fed chair did indicate that the central bank would be ready to raise rates as well if inflation were to come roaring back, but most observers concluded that the Fed was convinced that it had already delivered a “soft landing”, battling US inflation down while also maintaining high employment.

The euro zone is also faced with tumbling inflation, and the ECB kept interest rates on hold. However, its forward guidance was subtly different from that of the Fed. It indicated that it would speed up the central bank’s unwinding of its pandemic-era bond-buying scheme. This would have a tightening effect on monetary conditions in Europe. While the markets may expect an ECB rate cut at about the same time as the Fed cuts early next year, the European board is far more cautious about the path of rates and inflation than the Fed is. The Bank of England, meanwhile, specifically said its inflation fight was not over, and it seems it would be the last of these three central banks to ease policy. The UK is of course in a somewhat more precarious position than other economies, given that investor faith in its fiscal position was severely dented last year, forcing the Bank of England to raise rates higher than it had in 15 years.

The broader global economy, therefore, is faced with three very different views of 2024. The deeper divide may be between investors and market participants convinced that policymakers are underestimating how swiftly inflation might ebb out of the economy — and that they are also underestimating the damage that prolonged high rates would do to growth potential. The Fed, which has reduced its policy space considerably following last week’s statements, is in particular danger of making a policy error — either cutting too soon or staying too high for too long — that could again tighten financial conditions, and affect consumer and investor confidence. Much growth momentum and optimism in the global economy today come from the power of the US consumer, sitting on the pandemic-era stimulus and buoyed by exceptional employment growth. For countries like India, any sputtering of this US growth locomotive would be a negative. Expectations for global growth in 2024 are already below 3 per cent, at 2.7 per cent, as against an expected 3.1 cent in the current year. The downside risks to growth from central bank errors will now have to be factored in.