The US Central Bank (Fed) and the European Central Bank (ECB) released the minutes of their latest board meetings last week. They offer a glimpse into the monetary crystal balls of the banks. What did I find most spectacular? A two letter word.
It can be concluded from the ECB's report that the board members see all kinds of obstacles in the way of growth. This includes protectionism, geopolitical affairs, vulnerable emerging countries and volatility on the stock markets. Economic growth is lower than in 2018, but remains high. Lower is therefore not a synonym for low.
A look at the minutes of the Fed tells me that the committee members believe that the bank has the luxury of being patient with future interest rate increases. Americans also see the risk factors that European colleagues see. Some pointed out that (partly due to the significant drop in the oil price in the last months of 2018), inflation this year could be lower than what the bank expected.
What does this come down to? It means that the Fed will raise official interest rates at most twice this year, and will most likely only raise them once. I expect this to happen in March. At the ECB we should not be surprised if the bank also raises interest rates this year just again at 0%.
The two-letter word
What I found most remarkable, however, was the sentence in the Fed's report stating that rates are "at or below neutral levels" after the December hike. The problem is mainly the word 'on'.
Jerome Powell, the Fed chairman, said in October that the Fed's interest rate is quite far from neutral. This is the level at which the Fed neither slows nor stimulates the economy. When Powell says that rates are far from that level, he is essentially saying that the bank will continue to raise rates in the coming months and quarters.
However, in November Powell said rates were just below neutral rates. In other words: you can count on us only raising the official interest rate a few more times and then stopping. That bend was the most remarkable and sharpest in the more than 20 years that I have been working on central banks. And this appears to be even more remarkable and sharp after the publication of the minutes.
At the neutral level?
It is the word 'on' that points to this. That word says that the interest rate (according to members of the interest rate committee) is at the neutral level, instead of just below. This also means that further interest rate increases would slow down the economy and that is exactly what the Fed does not want. If Powell himself comes clean later this year (around autumn) and starts hinting at a rate cut, I will be anything but surprised.
In short: there is a good chance that the Fed will implement one interest rate increase this year, that the ECB will keep interest rates the same and that the Fed can start hinting at interest rate cuts in 1 in the second half of the year. This also indicates that short-term interest rates (such as EURIBOR) will remain at current levels for the time being.
Long-term interest rates
In addition, long-term interest rates in strong euro countries such as Germany may rise in the course of this year, mainly driven by still high economic growth, higher inflation, the fact that the ECB has stopped buying government and corporate bonds and the likely deepening of the eurozone.
The latter means nothing other than that the euro countries will act as guarantors for each other more and more directly, thus reducing the chance of a new euro crisis. For the strong euro countries, this means that they can be seen less as a safe haven. Another consequence of the changed course in the United States could be for emerging countries. More about that soon.