US Federal Reserve
figure 1
Despite positive developments on the inflation front, Jerome Powell expressed some concern that tight labor markets and strong real economic activity could halt inflation’s decline before it returns to target. He specifically noted that, historically, at least some degree of labor market pain is required to return inflation to target. So far, the labor market has experienced far less pain than the Federal Reserve anticipated. BCA Research has calculated that, depending on trends in labor force participation, monthly nonfarm payroll growth will have to average between -37k and +87k for the next six months for the unemployment rate to hit the Fed’s 4.1% end-of-year forecast.
The policy implication of falling inflation and better-than-expected employment growth is that the Federal Reserve will likely keep interest rates on hold between now and the end of the year. It will also be slow to embrace rate cuts in 2024 until the labor market shows signs of cracking. It is important to remember the lagged effect of monetary policy changes and so it is likely that the full extent of past rate hikes has yet to be transmitted to the US economy.
European Central Bank
Governor Christine Lagarde, during the press conference, stressed the data dependency of the European Central Bank in their decision on whether to hike interest rates again in September. Lagarde also offered no forward guidance. She once again stressed that the interest rate decisions will be guided by the assessment of the inflation outlook, dynamics of underlying inflation, and the strength of monetary policy transmission. She highlighted that the updated staff projections will be informative in assessing these dimensions in September. BCA Research has suggested that the odds are higher that July’s rate hike marks the end of the European Central Bank’s tightening cycle.
The latest Bank Lending Survey shows that credit standards have tightened in the Eurozone and net demand for loans declined in Q2 of 2023, with corporate loans falling to a record low. See figure 2.
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