ECB moves ahead of Fed in credit easing stakes

US-Europe economic divide a worry for policy-makers

The divide in US-European economic performance is widening – a worry for transatlantic policy-makers, likely to be reflected in the European Central Bank cutting interest rates more swiftly than the US Federal Reserve.

The economic implications of multiple elections around the world, the China slowdown and worldwide tensions caused by conflicts in Ukraine and the Middle East were key concerns at OMFIF’s advisory council meeting on 18 March. They overshadow the run-up to interest rate decisions at the ECB and Fed’s policy meetings on 10-11 April and 30 April-1 May respectively.

Participants at the OMFIF meeting acknowledged a surprising degree of US economic resilience – a sentiment since heightened by bullish data on US manufacturing and the personal consumption expenditures price index. Market participants are now expecting fewer US rate interest rate cuts in 2024 than those postulated by Fed policy-makers – a complete turnround from the position at the end of 2023.

The contrasting state of western economies is likely to put greater pressure on European fiscal budgets as governments try to shore up European economic performance and marshal more resources for defence. The lack of vigour in Europe would intensify the Old Continent’s vulnerability should a returning Donald Trump – if he wins November’s US presidential elections – fulfil his threats to enact tariffs and other punitive anti-European trade measures.

Data showing continued European economic sluggishness, together with a further fall in euro area inflation to 2.4%, have sharpened expectations of ECB interest rates cuts in the next few months. Robert Holzmann, governor of the Austrian National Bank, and widely seen as one of the chief advocates of stern anti-inflation policies on the 26-member ECB governing council, said the ECB could cut interest rates ahead of the Fed in view of the much less buoyant European economy.

In addition, Piero Cipollone, the newly installed Italian member of the six-person ECB board, has added to a persistent drumbeat of Italian calls for easier credit. Banca d’Italia economists have shown impatience in recent months at much-contested ECB statements that ‘the last mile’ in bringing down the inflation rate is the most difficult part of the monetary terrain. Very few commentators expect interest rate cuts at the ECB’s meeting next week. But odds have narrowed sharply on the first ECB cut since 2019 at the following meeting in June – with possibly by a further reduction in July.

Alongside the contrasting picture between the US and Europe, advisory council members highlighted a relatively stable outlook for developing and emerging market economies. Another silver lining was said to come from opportunities to improve productivity through the development of artificial intelligence technologies.

In continental Europe, following five quarters of quasi-stagnation, concerns about a hard landing have abated but there are scant signs of any significant recovery. Growth is projected to rise slightly to 1.5% in 2025. However, political tensions are inevitable in view of massive demands on public expenditure and the precarious position of many countries’ public finances.

The UK presents a more mixed picture. The March budget was described by a council member as ‘a non-event, but a relief compared to the turbulence 15 months ago’. There are fears that the government will fail to meet its inflation target by 2025.

While China’s economic slowdown has become a stark reality – and structural shifts dampen growth prospects – council members noted that actors in the region have prepared for this eventuality. The property market poses a significant concern, although the absence of highly leveraged real estate purchases mitigates the risk of a very sharp downturn. China’s state intervention in real estate has intensified concerns about productivity-dampening resource misallocation.

Despite the economic downturn, China’s commitment to transitioning towards a green economy offers a glimmer of hope for sustainable growth. A council member noted that the country generated 45% of growth last year from green manufacturing activity.

The outlook for African countries was seen as more stable. Out of 73 scheduled elections worldwide this year, 19 are across the continent. One meeting participant put forward a source of solace: African countries can benefit from a ‘demographic dividend’, democratic stabilisation and intra-continental cooperation – providing some compensation for cross-border repercussions of global tensions.

David Marsh is Chairman and Arunima Sharan is Senior Research Analyst at OMFIF.

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