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Today’s announcement by the European Central Bank to cut interest rates by a quarter-point to 3 % is yet another sign that central bankers are more worried about economic growth than about inflation. This recent cut is the fourth such reduction in borrowing costs since June. The ECB warned that the Eurozone would grow at a rate of 1.1% next year and 1.4% in 2026. Chairperson, Lagarde expressed concern that “the element which has changed is the downside risks, particularly the downside risks to growth”. She added that Trump’s threats to impose widespread tariffs on all US imports did not figure in the Bank’s calculation of its baseline forecast. Moreover, the ECB’s dropped any reference to a continuation of a restrictive monetary policy to tackle inflation. The concern with growth now dominates monetary policy deliberations.
Yesterday, the Bank of Canada announced a significant shift in policy, cutting its policy rate a further ½ point to 3.25%. This move can only be interpreted that the Bank remains behind the curve as the Canadian economy continues to soften further. The economy expanded by a meagre 1% annualized in the last quarter, well below the 1.5% anticipated in the Bank’s earlier forecasts. Most worrisome is the rise in unemployment, reaching 6.8% last month as job growth failed to keep up the expansion of the labour force. Overall, aggregate demand falls short of what is needed and aggregate supply suffers from very poor productivity performance. The intersection of these two curves explains Canada ‘s underperformance.The US Fed seems in less of a hurry to drop rates, especially since the most recent evidence is that growth is holding up.However, Chairman Powell has gone on record that the Fed can afford to cut its benchmark rates with caution because the economy is able to expand and inflation has come down considerably. Fed watchers now expect the fed funds rate to settle into the 3.00% -3.25% range by the end of 2025, compared to the current rate of 4.5%.The wild card in all these forecasts is the fiscal policy positions adopted by the incoming Trump administration. Immediate post-election, the financial markets experienced an upward surge in the 10yr bond yield and a considerable strengthening of the US dollar. These movements reflect a legitimate concern that the US federal deficit will soar, resulting in much higher borrowingcosts. At this point, central banks have a very difficult time developing a longer term strategy until the US budget positions become clear. Then there is the matter of US tariffs. Growth everywhere will be ata muchgreater risk should Trump follow through with threats of 25% tariffs on all its imports. No one country can escape an economic downturn due to a tariff war.More By This Author:Trump’s Bark Is Worse Than His Bite When It Comes To Canada-U.S. TradeThe Trump Tariffs And The Canadian Economy: A Different Perspective Once Again, The Bank Of Canada Is Too Slow To React
