Captivating Divergence: Analysts Suggest Central Banks' Interest Rate Cuts May Vary

The financial markets are currently anticipating nearly identical policy easing by the Federal Reserve, the Bank of England (BoE), and the European Central Bank (ECB) by the end of next year. Projections include an easing of 135 basis points (bp) from the Fed, 134 bp from the BoE, and 133 bp from the ECB. However, economic indicators suggest that this synchronization may not persist.

So far, the Fed has implemented a 50 bp rate cut in line with the ECB, while the BoE has taken a more modest approach with a 25 bp reduction. Despite these parallel moves, economic landscapes in the US and Europe are diverging.

The US economy is demonstrating robust growth, with GDP running above 3% and upward revisions to forecasts, alongside a strong labor market. These factors could point to a potentially shallower rate cut cycle for the Fed, with the terminal rate possibly closer to 4%.

In contrast, the eurozone is experiencing inflation below the ECB's 2% target, with some countries like Ireland seeing inflation under 1%. Germany, the bloc's key economy, faces the risk of a second consecutive annual GDP contraction.

Economists from global banks predict that the ECB may need to implement more aggressive rate cuts than currently priced in by the markets, potentially 50 bp at every meeting in the first half of next year.

Nomura's European economists suggest the terminal rate could be slightly below 1.50%, while Morgan Stanley's analysis indicates the ECB's nominal neutral rate could be as low as 1.0-1.4%.

The UK's economic situation is not as dire as the eurozone's, yet analysts are surprised by expectations that the BoE will ease as much as the Fed. Goldman Sachs analysts estimate the UK's nominal neutral rate to be around 2.75%, implying that the BoE may need to cut rates more than currently anticipated.

Divergence in interest rate paths could have implications for currency markets. If US rates fall less than those in Europe, it could challenge expectations of a weaker dollar. A stronger dollar could benefit the eurozone by making the currency cheaper, potentially supporting inflation and boosting exports, especially given the economic challenges faced by China, a key trading partner.

Traders might hesitate to adjust rate forecasts due to current uncertainties surrounding the upcoming US election. However, as the political landscape becomes clearer, adjustments in expectations for central bank policy easing are likely to emerge.