Will the FED cut rates by 25 or 50 bps?

Where did the 25-or-50 debate in the US come from? Steve Barrow, Head of Standard Bank G10 Strategy said that it would seemingly stem from three main considerations.

The first is that the Fed has started to cut rates later than many others and hence may need to catch up.

The second is that the Fed also has a target of full employment as well as price stability, whereas most other central banks only have the latter. This would seem to suggest that if achieving inflation reduction comes at a cost of rising unemployment the Fed should be ready to act on rates more boldly than we see elsewhere.

The third factor is that some see the US on course for a recession that could even occur in the context of a tight labour market and full employment. “While we think a 50-bps rate cut from the Fed would be a perfectly reasonable decision at this juncture, we lean towards 25-bps on the basis that the Fed is accustomed to starting slow and then speeding things up, unless, that it, it is responding to a crisis. For instance, the tightening cycle from March 2022 started with a 25-bps hike, but quickly stepped up to much larger increases,” said Steve Barrow, adding that if any central bank needs to cut 50-bps right now, it is the ECB.

The ECB also tends to start small in non-crisis situations although its ‘plans’ to start the tightening cycle with a 25-bps hike in July 2022 had to be replaced by a 50-bps hike as the scale of the inflation problem revealed itself. Fast forward to this year and the ECB has started with a 25-bps rate cut in June and is expected to follow this up with another 25-bps reduction on Thursday. The market is fully priced for a 25-bps cut, and all 67 analysts in the Bloomberg survey expect a 25-bps rate trim.

In short, it is very hard to bet against anything other than a 25-bps cut. But the problem in Steve Barrow’s view is that developments since the last rate cut, and the last set of ECB forecasts in June, seem to him to justify more aggressive action. For a start, the economy seems to be rolling over again after a slightly better first half of the year. Secondly, CPI pressure remains becalmed. Not only has the annual inflation rate fallen very close to target at 2.2% but the monthly price rise in each of the last three months has averaged an annualised increase of just 1.5%. Add in other factors such as the big plunge in oil prices and it looks to us that price pressures are easing much faster than previously anticipated. Even on the wages side, which has been of constant concern to the ECB, the most recent data on negotiated wages for Q2 has shown a pretty substantial plunge to 3.6% from 4.7% in Q1.

Could these factors, and more, push the ECB to a 50-bps rate cut this week? It seems unlikely as there seem to be enough hawks on the ECB to push back against bolder action. In Steve Barrow’s view, that would be a shame; if the ECB wants to avoid another slide in growth, it should cut 50-bps at this juncture as the risks of an inflation flare-up seem very limit ed. If the Bank does opt to play it safe with a 25-bps cut this week, the cost of this will be more slippage in growth prospects and a deeper slide in inflation which will ultimately force the Bank to step up to the plate further down the line with rate cuts of 50-bps, or more. Again, none of this is priced into the market.  The overnight interest swap (OIS) curve is priced for cuts of no more than 25-bps at any meeting through the easing cycle.

“We think that’s too sedate. For even if the deposit rate falls to around 2% by the end of the easing cycle, which is the level broadly priced into the curve, we think it will hit this rate sooner than the current market pricing of Q3 2025,” said Steve Barrow.