Over-estimating easing
Substantial rate cuts in most economies are to be expected but what’s up for debate is the speed at which markets are currently pricing further cuts
INTEREST rate cuts in advanced economies are likely to gain traction relatively quickly, even with China’s structural challenges deepening. This suggests this easing cycle will be less linear than markets have been pricing.
By the end of 2024, rates in many jurisdictions, particularly the United States, United Kingdom, European Union and New Zealand, are all likely to be meaningfully lower than their recent peaks. The UK has already delivered 25 basis points of easing, the US 50 and EU and New Zealand 75.
Markets are currently pricing extensive and speedy further cuts, which in broad terms involves central banks lowering rates at three-quarters of their meetings and cumulatively and speedily removing a third to a half of the aggressive tightening of 2022 and 2023.
The view that neutral interest rates are substantially lower than the rates that have applied in recent years is uncontroversial. The level of interest rates required to ensure a peak in inflation and then decline back to target will almost certainly be too high to ensure inflation stabilises around the target rate.
What is up for debate is the speed with which markets are pricing this normalisation. Not only have deep recessions been avoided, but the absence of recessionary dislocation also implies rate cuts will generate traction relatively efficiently.
Time to recover
Deep recessions are characterised by large-scale unemployment and bankruptcies. Following the stress of a recession, consumers and businesses typically respond timidly to rate cuts, and confidence takes time to recover. Defaults and delinquencies accumulate on balance sheets, making banks hesitate to lend early in the recovery.
But unemployment has risen only modestly this cycle, and rising bankruptcies have generally been sector-specific. Falls in confidence seem to have reflected the rise in inflation more than the loss of jobs and business. This suggests confidence will recover as inflation returns to target and interest rates come down.
Perhaps the most remarkable example is New Zealand, where the ANZ Business Outlook Survey suggests confidence is at its highest level in a decade. In Australia, confidence has recovered only around a quarter of its decline, but modelling suggests it will recover more quickly into the close of the year.
In the US, for instance, when the Federal Reserve eases, bank lending standards are typically tightening and unemployment rising sharply. But so far this cycle unemployment has only risen a very modest three-quarters of a percentage point. Bank lending standards tightened as the Fed was raising interest rates but the pace of tightening has been slowing for the past year.
It seems likely the tightening in financial sector regulation that began after the global financial crisis and continues to the present day has played a significant role. Banks are much more creditworthy because they hold more capital as well as lending against tightened standards. The latter implies the average borrower is likely to be able to handle difficult conditions with less financial stress.
China continues to operate on a different cycle. The GDP deflator suggests it has been in deflation for the past two years, the 5 per cent GDP growth target for 2025 is a challenging goal and while easing has become more forceful, it is more likely to stabilise GDP growth for a period than boost it.
In my view, much of China’s slowdown is structural rather than cyclical. An ageing workforce, declining population, high levels of debt and increasing trade restrictions for an economy operating an invest-to-export model, suggest a 3 to 4 per cent growth rate over time would be a fortuitous outcome for China. Even productivity growth is likely to continue to slow as these influences act on the economy.
Importantly, however, negative spillovers for the region have been modest thus far and are likely to remain so. India is likely to grow at 6.5 to 7 per cent over the next couple of years, and the region ex-mainland China and India to sustain the 3.5 to 3.75 per cent pace of the last two years.
The likelihood of further easing seems unarguable. We forecast substantial rate cuts in most economies, apart from Australia where we anticipate only 75 basis points of easing. But the easing priced by markets is excessive, in my view.
The writer is chief economist at ANZ
