Who will cut interest rates first: the Fed or the ECB?

All indications are that the Fed will be the first to cut interest rates. The ECB will probably do this later. The market assumes the same. The hypothetical January contraction in the US is estimated at nearly 35 percent. chances, while the first reduction of the eurozone is possible only in March, although the probability of such a move is small and amounts to about 26 percent. These differences in market valuation can be due to several reasons.

Unlike the ECB, the Fed has a dual mandate. He cares not only about price stability (target inflation rate of 2%), but also about a high level of employment. Therefore, he must take into account the state of the labor market. If the inflation target appears to be met, the Fed should seize the opportunity to cut interest rates faster in the interest of high employment.

Inflation in the US and Europe falls

Inflation in the US fell more sharply than in the euro area. The main US index peaked last fall. The same European counterpart so far peaked in March of this year, and there has been no clear decline since then. Of course, the main CPI in the US and Europe has moved away from its highs compared to last year, but here we have had shifts in time. In the United States, inflation peaked in the middle of last year at just over 9 percent.

In the euro area, this moment came in October and showed a value of 10.6 percent. This factor also speaks in favor of an earlier Fed rate cut. The US monetary tightening process has also been stronger. The Federal Reserve started the cycle earlier than the ECB and has so far reached a higher level (5.5%) than its European counterpart (deposit rate of 3.75%).

The Fed was much firmer

The Fed also took much more drastic steps, achieving a change of as much as 75 basis points. If monetary policy “overseas” is more restrictive (and everything points to it), it also means that the US central bank simply has more room to cut. It should also be taken into account that the latest “scatter plot” indicates that US policymakers themselves expect the value of money to decline in 2024 to 4.6 percent. Thus, this year the EUR/USD pair still has some upside potential.

Earnings could pick up when the market is confident that the Fed has completed its bull cycle and speculation about the date of the first moment of policy easing intensifies. If this is combined with the restrictive position of the ECB (since inflation will fall at an unsatisfactory pace), then the growth of the main currency pair may increase.