By Paulo Trevisani and Emese Bartha
A September interest rate cut in the U.S. could make it easier for other major central banks to loosen monetary policy.
The Federal Reserve kept rates steady Wednesday, as expected, but for the first time indicated that it could start cutting them at the next meeting.
The Fed's decision comes as central banks around the world, after tightening financial conditions almost in lockstep during the fallout of Covid-19, have started or are preparing to return to more normal fiscal policies.
Divergent policy rates, and the expectations on what central bankers are going to do next, have been key drivers for foreign exchange markets. Investors have sought currencies with higher rates, boosting their value relative to lower-rate ones, in so-called carry trades.
"Other central banks' policy decisions will primarily be determined by each country's economic and financial conditions," said Jumana Saleheen, head of Vanguard's investment strategy group for Europe. "But in a globally interconnected world, other central banks cannot ignore the impact that the Fed…has on global financial conditions."
The Swiss National Bank has delivered two interest rate cuts of 25 basis points each, as has the Bank of Canada, while the European Central Bank has reduced rates once and is widely expected to do so again in September. The Bank of England on Thursday cut the bank rate to 5% from 5.25%.
The BOE is "embarking on what is likely to be a moderately paced, but durable easing cycle," said Daniel McCormack, head of research at Macquarie Asset Management.
A conspicuous outliner is the Bank of Japan, which has for years kept rates near or below zero. On Wednesday, it raised the key policy rate to 0.25% from a range of 0%-0.1%.
A Fed cut would facilitate monetary easing beyond the U.S. Central banks typically focus on local economic indicators to make rate decisions, but a wide gap relative to U.S. interest rates could send currencies up and down and have an impact on inflation and economic growth.
Lower interest rates would help keep the U.S. economy stronger than its developed counterparts, boosting the dollar, said Michael Brown, senior research strategist at Pepperstone.
While other central banks have a single mandate of stable prices, the Fed has a dual mandate, also aiming to maximize employment, which is showing signs of weakening.
Fed Chair Jerome Powell said after this week's decision that an initial cut, likely by 25 basis points, could be on the table in September.
"We're getting closer to the point at which it'll be appropriate to reduce our policy rate," Powell said to reporters Wednesday.
On Thursday, markets were pricing 86.5% odds of a September Fed cut by a quarter of a percentage point and 13.5% probability of a trim twice as big, according to CME Group data.
The risk of a slowdown in some economies makes the Fed policy even more important for other central banks.
Second-quarter eurozone growth data was a meager 0.3% expansion over the first quarter, underscoring the importance of a September ECB rate cut. The balance of risks in the Eurozone is "gradually but increasingly shifting to more ECB rate cuts being priced in," said Andrzej Szczepaniak, European economist at Nomura.
ECB President Christine Lagarde kept the door open to a possible rate cut in September at the July 18 meeting.
To be sure, Fed policy isn't necessarily a key driver of monetary decisions elsewhere.
The ECB could continue to evaluate the euro area's economic situation independently and base its decisions on local data, said Michael Gelpke, CEO at Aymara International Fund.
"In this regard, the ECB has already started to reduce its interest rates before the Fed and could continue to soften its monetary policy in light of the weaker economic conditions and the nearly inexistent economic growth compared to the U.S.," he said.
Write to Paulo Trevisani at paulo.trevisani@wsj.com and Emese Bartha at emese.bartha@wsj.com
(END) Dow Jones Newswires
08-01-24 0945ET
