Central Bank Tracker: Bank of England expands group of rate cutters, but markets are still waiting for the first Fed move

Insights for What’s Ahead

• During July (and early August), the pendulum of developed market (DM) monetary policy continued to swing ever so slowly in the direction of the interest rate cutters. July (and early August) brought us another interest rate cut in Canada and the first one in the UK, offset somewhat by a second interest rate hike this year in Japan. Our ‘Hikers vs Cutters’ chart (see Figure 1) shows the steady but slow accumulation of rate cuts.

Figure 1

• Approaching balance. Five of the twelve DM central banks The Conference Board tracks regularly have started their respective interest rate cut cycles. One, the Bank of Japan, is moving in the opposite direction for idiosyncratic reasons, leaving six banks that have yet to pull the trigger on a first interest rate cut.
• The Conference Board developed market monetary policy rate average has yet to progress much. The (GDP-weighted) DM central bank policy rate average increased a basis point following the Bank of Japan’s interest rate hike on July 31 before moving back down by the same amount following the Bank of England meeting. At 4.12%, the DM average remains stuck at the same level reached at the end of June (see Figure 2). Meanwhile, with data available through the end of June, the GDP-weighted DM inflation average improved another two-tenths of a percentage point to 2.7%, moving closer to the 2% target.  

Figure 2

• Real policy rate differences remain extremely wide. Looking at real policy rates (nominal interest rate – annual inflation rate), we can loosely group the twelve DM central banks into five groups (see Figure 3). According to most studies, the neutral real interest rate at which monetary policy neither restricts nor stimulates economic activity is between 0% and 1% for most DM economies. Right now, only Australia’s RBA is in that category (group #1) – although the Swiss National Bank, the Bank of Korea, and the ECB are only marginally outside that range (groups #2 and #3). On the more extreme ends (groups #4 and #5) are the Bank of England (despite the recent rate cut), Sweden’s Riksbank, the Federal Reserve, and the Reserve Bank of New Zealand, all of which have real interest rates well above 2%. The opposite extreme is the Bank of Japan, which still faces real interest rates at -2.6% despite two rate hikes this year. This framework can can be used to assess the potential for interest rate cuts or hikes.      

Figure 3

It is a busy summer for central bank watchers as the Bank of England joins rate cutters and the Bank of Japan continues to hike rates

The Bank of England cut policy rates 25 basis points to 5.25% during their August 1^st meeting (see Figure 4). The decision was close, with five of the nine Monetary Policy Committee (MPC) members voting for a rate cut; the other four preferred to leave rates unchanged. UK inflation has slowed to the bank's 2% target. Yet, the gap between deflationary annual goods inflation (-1.4% during June) and still very elevated services inflation (+5.7%) remains extremely wide, and the bank expects headline inflation to pick up again over the remainder of the year. Despite that, the policy statement highlighted the MPC’s view that “it is now appropriate to reduce slightly the degree of policy restrictiveness.” Even after the cut, UK real policy rates at 3% are still the highest among the major DM central banks we follow (see Figure 3).

Figure 4

The Bank of Japan (BOJ) continued the gradual change in monetary policy that started during March with the bank’s first rate hike in seven years, which finally ended the period of negative interest rates. Following the 15-basis-point rate hike during March that took the key policy rate from -0.10% to 0.05%, the July meeting added another 20 basis points to push the interest rate to 0.25%. But that was not all. In its policy statement, the BOJ acknowledged that real interest rates remain deeply negative and financial conditions remain very accommodating. Hence, the bank expects further interest rate hikes if the economy evolves as expected. The BOJ also announced a reduction in its asset purchase program. Since 2016, Japanese Government Bond (JGB) purchases aided the bank's Yield Curve Control policy and pushed down longer-term bond yields. Last October, the BOJ essentially ended that commitment. Since then, asset purchases have mainly prevented the balance sheet from shrinking. The latest policy change will start the process of balance sheet contraction (often referred to as Quantitative Easing or QT), which the BOJ indicated will shrink the balance sheet by 7-8% over the next two years.

Figure 5

Meanwhile, both the Federal Reserve and the ECB left policy rates unchanged during their July meetings. The Federal Reserve kept policy rates at 5.375% (the midpoint of the 5.25%—5.50% target range). Fed Chair Powell highlighted that the committee still required more confidence that inflation has eased enough to start cutting rates. But he also suggested that the right conditions for such a decision could be achieved as soon as September (for more on the FOMC meeting, see "Fed still Looking for Confidence to Cut”).

Figure 6

The ECB also left policy rates unchanged at its July meeting. The bank cut rates in June, arguing that “it is now appropriate to moderate the degree of monetary policy restriction." Yet, the renewed pause showed that the pace of adjustment will be slow. At 1.2%, eurozone real policy rates are not too far above the 0%—1% neutral range. Hence, further interest rate cuts will likely require further slowing in euro-area-wide CPI inflation.

Figure 7

The Bank of Canada followed up on its first 25-basis-point interest rate cut in June with a second one in July. Canadian headline inflation at 2.7% remains above the 2% target, but the bank sees excess supply conditions emerging as strong population growth keeps Canada’s potential output growing faster than GDP. A widening output gap and the already deteriorating labor market should drive continued improvement in the inflation outlook in the future. At 1.8%, Canadian real policy rates remain elevated, which suggests there is room for the bank to cut interest rates further this year while still maintaining restrictive monetary policy conditions.

Figure 8

Also last month, the Reserve Bank of New Zealand (RBNZ) left policy rates unchanged at 5.50%, the highest nominal rate among the twelve DM central banks we follow. However, the bank’s policy statement opened the door for a first interest rate cut in the coming months. It highlighted that inflation should soon return to the RBNZ's 1% - 3% target range. Price pressures, while still high, are receding, and “economic activity is consistent with the restrictive monetary stance." At 2.2%, New Zealand’s real policy rates are not as high as those in the UK and the US. However, a further slowdown in the country's inflation rate in Q3 would open the door for at least two interest rate cuts later during the year to prevent a renewed rise in real policy rates.    

The Bank of Korea left policy rates unchanged at 3.50%. For now, the policy statement highlighted the necessity to “further assess whether inflation will continue its slowing trend.” However, the statement also mentioned that "the Board will examine the timing of a rate cut," suggesting the discussion on when to cut rates has started. Korean real rates at 1.1% are only marginally above the 0% - 1% neutral range, suggesting that without a further decline in the inflation rate, there is not much room for interest rate cuts this year.

The rest of August has a more central meetings on the schedule

In addition to the Bank of England, other monetary policy meetings on the calendar during August include the Reserve Bank of Australia (August 6), the Reserve Bank of New Zealand (August 14), Norway’s Norgesbank (August 15), and Sweden’s Riksbank (August 20).

The Riksbank is the most likely to deliver another interest rate cut among those four. Swedish inflation has fallen to 1.3%, and real policy rates at 2.4% are on par with those of the US, where CPI inflation is more than twice as high. That suggests there is room for the Riksbank to moderate the degree of monetary policy restriction further in the coming months.