Policy Mixology

Paradoxically, although it is now consensus that the Fed should have been more prudent in September, the market is now almost exactly aligned with the FOMC’s dot plot. We have been warning against reading too much into such forecast given the imminent election in the US which could have some quite different effects on inflation. Such uncertainty does not exist in the Euro area. Of course, Europe has its own sources of political tension, but at least the fiscal stance for next year is clear: based on the government pledges in the three largest economies, the adjustment will reach 0.9% of GDP in the Euro area. This cannot be ignored by the ECB. Estimates of the impact of fiscal and monetary policy on GDP vary, but very few would argue that next year’s fiscal austerity won’t have some dampening effect on an already mediocre domestic demand. This should be among the reasons for which we think the ECB should depart from its “one meeting at a time” mantra, to which it stuck again last week. The fact that the Governing Council was unanimous in condoning a back-to-back cut which would have been very contentious just a few weeks ago is positive, but even if some measure of data dependence will of course remain, there is now enough clarity on the kind of internal risks to growth the Euro area is facing to warrant a less reactive approach. Next week in London the Chancellor of the Exchequer will unveil the budget for 2025. We think the UK presents a very clear case of potential cooperation between the central bank and the government, as a front-loaded fiscal adjustment is coming. We continue to reserve judgement on China’s fiscal stimulus as long as we do not get more precise information. We note that the market tends to react very positively to noises about a significant rise in central government debt issuance. If a large fraction is directed to a swap for local government debt, this may be positive in terms of financial stability, but the direct impact on activity could be quite limited.