Policy rate divergence is not a narrative that will last for long

ECB President Christine Lagarde says she is confident inflation is under control.
ECB President Christine Lagarde says she is confident inflation is under control.


  • The ECB’s rate cut diverges from Fed policy but we mustn't over-interpret it. The shifts of central banks reflect the strength of underlying economies and the tenacity of inflation.

After a period of relative uniformity among major monetary authorities, it’s suddenly fashionable to talk of divergence in the path of interest rates. Unfortunately, this easy description papers over some important—and subtle—differences that have emerged over the past year. Such course corrections are healthy. The US central bank, the Federal Reserve, is not the only show on earth.

When traders speak about separation in the direction of borrowing costs, what they tend to mean is that one of two central banks from the G7 are doing something before the Fed. The notion has been given momentum by rate reductions from the Bank of Canada (BoC) and European Central Bank (ECB). 

They followed similar steps by Sweden and Switzerland. Protagonists play down the risks of moving before Washington: We do what our domestic conditions warrant, we don’t have to march in lockstep. Yes, we are worried about dollar strength, but we are sovereign, etc. In decades of covering central banks and markets, I have heard a lot of that talk. Sometimes, there is substance to it.

Also read: Central banks are marching to different beats again—and that’s good news

Of course, officials have domestic mandates and, absent crises, must be guided by the local terrain. But look at a broader horizon and there’s a noteworthy fading of synchronization that doesn’t get as much attention. Important central banks in Latin America have been trimming rates for a while: Brazil has been at it since August, while Mexico, Chile and Peru have also made policy easier. 

China didn’t hike at all, and economists are pencilling in a few cuts. The Reserve Bank of New Zealand considered resuming tightening, while its Australian counterpart has repeated ad nauseum that nothing is ruled out. Indonesia surprised with an increase.

The separation represents a shift from the early days of the pandemic, when massive easing was commonplace and done with startling alacrity, often in emergency meetings. The contemporary variety is also a turnaround from late 2021 and 2022 when the supply-chain constraints that accompanied the reopening pushed inflation up rapidly. The uniformity during these two dramatic periods led me to wonder in 2022 whether the era of the global central bank, a contentious assertion, had arrived. That harmony is fading.

The BoC’s Senior Deputy Governor Carolyn Rogers put it well: “Although we were quite coordinated on the way up—and that was really helpful because a big part of inflation was global—you’re going to see some divergence on the way down and that makes sense." 

Also read: The ECB's leap ahead of the federal reserve

Rob Subbaraman, head of macro research at Nomura, was more succinct at a conference in Singapore: “We are moving away from the global shocks that held things together." The MSCI Emerging Markets Currency Index has almost climbed back to its levels of three years ago.

Looked at from a truly global perspective, the ECB and BoC are less bold departures and more like components of a mosaic. The shifts reflect the strength of underlying economies and the tenacity— or otherwise—of uncomfortable levels of inflation. Canada’s central bank was heartened by a fourth month of price gains staying within the target range. 

In the euro zone, growth is far weaker than across the Atlantic. ECB President Christine Lagarde says she is confident inflation is under control. Fed Chair Jerome Powell has the benefit of a more resilient economy and has said there is no rush to cut. He’s also been chastened by hot inflation data.

There will be limits just how far in front of the Fed some of these central bankers are prepared to get. Most economists do predict some reductions from Powell, this year, though later than anticipated in January. A gap of a few months doesn’t make for an enormous disruption. 

The rate cycles may not match perfectly, but they do tend to broadly align over time. Unlike the present, it’s often the Fed that makes the first move. That’s tough this time, with Powell’s preferred measure of inflation at 2.7% in April, compared with a target of 2%.

Also read: Traders question case for rapid ECB rate cuts

One of the more memorable quotes from 21st century banking came from Wim Duisenberg, the ECB’s first chief. The Fed had cut in the early weeks of 2001 and, with the euro-zone economy softening, Duisenberg was regularly quizzed on when he would follow. Duisenberg was a hawk. 

His response at one point was “I hear but I do not listen." Nevertheless, the ECB did eventually ease and kept doing so. The Fed casts a long shadow, as does the greenback whose value it is required to protect. When Bank Indonesia ratcheted up rates last month, its governor began his press conference with a mention of the Fed.

‘Divergence’ will do well on internet searches for a bit. Enjoy the moment while it lasts. Just remember there’s far more to it than what’s uttered from podiums in Ottawa and Frankfurt. ©bloomberg

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