European Convergence
- 13 May 2024 (10 min read)
The Riksbank was the second central bank, after the Swiss National Bank, to cut rates in Western Europe. The Bank of England’s message last week was dovish, consistent in our view with a rate cut in June, or August at the latest, and Bailey’ warning that the BOE may have to cut more than what the market currently expects strengthens our call for a total of three 25-bps cuts this year. The minutes of the ECB’s April meeting were even more explicit than Lagarde in her press conference in telegraphing a rate cut in June, qualified as “plausible”. The scenario of a general “European wave” of monetary easing before the summer, in contrast with a more hesitant Fed, is now stronger.
The risk of undershooting the inflation target and inadvertently bring about an excessive cost to output and employment is creeping up in European policymakers’ minds. While the Riksbank may now be lauded for daring to cut earlier than the ECB despite the weakness of the Krona, the Swedish central bank may have in fact waited for too long before starting to reverse its stance. In a context of recession and significant rise in unemployment, the Riksbank is now forecasting that inflation will fall below 2%. A key dovish message from the Bank of England last week was its new forecast in which inflation would fall significantly below 2% towards the end of the projection horizon if the market’s expected path for monetary policy materialises. The undershooting risk was also one of the arguments used by the doves at the ECB when they called for a cut in April already.
The ECB minutes however pointed to much concern about what the Fed could do in the face of resilient inflation in the US. Given the dominance of the US market, it is natural that European policymakers carefully monitor the macro and policy developments there. But we have been arguing since the beginning of the year that the risks are asymmetric across the Atlantic, with inflation undershooting a potential risk in Europe, against a sizable overshooting risk in the US. Reading Europe with American lenses could lead to costly policy mistakes.
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