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Rate Cut Before US Vote? Here’s Fed and ECB’s Dilemma

Last Updated February 13, 2024 3:02 PM
Giuseppe Ciccomascolo
Last Updated February 13, 2024 3:02 PM

Key Takeaways

  • The Eurozone is facing slow growth and high inflation, with a risk of recession in the first half of 2024.
  • This could negatively impact the upcoming European elections, potentially benefiting populist movements.
  • The US is increasing its budget deficit to fund its initiatives.
  • What’s holding central banks back from cutting rates?

As the US grapples with the reshoring of the tech industry, Germany faces a process of industrial restructuring with the disappearance of low-cost Russian energy and the ban on internal combustion engines. While Joe Biden digs into the deficit bag, Olaf Scholz is at a crossroads between budget rules and business uncertainty.

As the two big economies face several political and economic issues, will the Federal Reserve and the European Central Bank cut their rates?

A Data Overview

If we look at the overall Eurozone data , the ECB should not wait for lower rates.  After an entire year where quarterly trends alternated between +0.1% and -0.1%, and unemployment which, on average, stands at 6.4%, there was zero round growth recorded at the end of December. Every month of waiting could push GDP trends into the red. This would, in turn, mean consequences that would be difficult to remedy.

Average inflation, however, still floats at 3.4%. One one hand, countries such as Italy are in the lowest range with 0.5%. On the other hand, the likes of France and Germany, navigate at 3.4 % and 3.1%.

A negative economic performance in the first two quarters of this year, particularly in light of the upcoming European elections scheduled for June, would exacerbate challenges in garnering popular support for both incumbent governments and traditional political parties.

This could further bolster radical movements advocating nationalism and anti-Europeanism. This has already happened, with the rise of RN in France and AfD in Germany, alongside existing tensions in Hungary and Czechia.

Why Is The ECB Waiting?

By maintaining a still restrictive monetary policy, as the Fed has just done by dampening expectations for a rate cut as early as March, the ECB would assume a very significant political responsibility.

In recent years, the ECB has accrued significant debt to Germany. This is primarily due to highly negative rates on Bunds and bonds resulting from expansionary monetary policies, including zero interest rates, quantitative easing, and the PEPP. These policies have decimated savings and caused distortions in property prices. Indeed, the index more than doubled between 2012 and early 2022.

There is a further similarity between the US and German situations, which the ECB cannot overlook. Last December, the two countries’ unemployment rates were 3.7% and 2.9%, respectively. In both economies, the labor market is already very tense. Further hiring by companies, triggered by the improvement of the economic prospects due to a lowering of interest rates, would determine new pressure on wage levels and, therefore, on prices, after the adjustments just adopted to take inflation into account.

On the other hand, it is the same annual trend in consumer prices. Last December, the US scored 3.3% while Germany’s consumer inflation was 3.7%. This, in turn, leads us to avoid untimely accelerations in the lowering of rates.

Biden And Scholz Geopolitical Issues

Then two opposite aspects characterize the economies of the United States and Germany. These, in turn, share a need for profound restructuring. While the first bases its dynamics on internal demand and the second on foreign demand, both require strategic rethinks in a geopolitical key.

The US is grappling with the reshoring of industrial activities in cutting-edge technological sectors, such as the construction of electronic chips and the development of artificial intelligence (AI), and the energy transition which receives funds from the federal government through the Chip Act and the Ira Act. This in order to counter competition from China, which is trying to become the world’s leading economy.

Germany must face a process of drastic industrial restructuring in the fields of chemistry, mechanics, and automobiles.

The bridges built by the country towards Russia and China are now undermined by shifting geopolitics in this phase of deglobalization. Chancellor Olaf Scholz must now constitutional rules mandating a balanced budget with uncertainty surrounding German companies’ prospects for relocating plants abroad. Meanwhile, in America, President Joe Biden is addressing the public deficit.

But Monetary Policy Can Do Little About Political Issues

In both cases, it is certainly not a lowering of interest rates by the Fed and the ECB that can resolve such complex issues. These matters are, eminently, political issues. This is the crux of monetary policies dealing with the upcoming elections. It is not a question of reviving the economic cycle by lowering interest rates, but of setting a completely new one.

Once again, not only does the German problem stand out as central to the future of Europe, but Germany’s needs do not coincide with those of the other Eurozone states. The ECB knows well how the stability of the currency is fundamental for Berlin, and how dangerous the growth of a German far right eager for a new opportunity to impeach European institutions is.

As the farmers’ revolts have demonstrated, it is Brussels’ dirigiste approach to environmental matters that is deeply contested, together with the guilty compliance of national governments.

Neither the war in Ukraine, nor the conflict in Israel seem to have frozen the deep disagreements shaking Europe. Neither will it be a late and limited reduction in interest rates that will resolve these issues. But, avoiding the worst, the European economy veering into recession, would be more than necessary.

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