Why are Central Banks Cutting Interest Rates?
Introduction
Inflation is falling across the world and central banks are thinking about rate cuts. Or are they? It appears that the disconnect between central banks and financial markets continues. Both groups operate with the same facts but attach different interpretations to them. One central question remains in 2024. When should central banks cut rates and by how much?
Central Banks’ interest rates are determined by inflation, or at least they were!
In 2024, the market consensus was for the Federal Reserve to cut interest rates 3–4 times even as inflation remains well above the bank’s target. On a year-by-year basis, inflation fell from 3.5 to 3.4% in April 2024, and the Federal Reserve Bank projects that inflation will reach 2.4 and 2.2 in 2024 and 2025 respectively. So why were markets pricing in 3–4 cuts or 1–2 cuts as they currently do? Core inflation that excludes volatile components of energy and food fell to 3.6% from 3.8% in March 2024.
It’s the same story in the United Kingdom, where inflation is well above the central bank’s target and averaged 3.4% y/y between March and April 2024 and will likely average 2.2% according to Treasury staff (Ministry of Finance) in the UK. Meanwhile, core inflation- which excludes volatile components like energy and food — fell 3.9% from 4.2% in…
