Internal Bank of England models now indicate its policy stance might have shifted to neutral or even slightly accommodative. This internal uncertainty about the true restrictiveness of rates could limit how much further easing the UK market can price in.
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The Fed's latest projections are seemingly contradictory: they cut rates due to labor market risk, yet forecast higher growth and inflation. This reveals a policy shift where they accept future inflation as a necessary byproduct of easing policy now to prevent a worse employment outcome.
Because the neutral rate of interest (R-star) is a theoretical, unobservable concept, policymakers can manipulate its estimated value to justify their desired interest rate policies. This allows them to argue for rate cuts or hikes based on a non-falsifiable premise, making it a convenient political tool rather than a purely objective economic guide.
ECB President Lagarde's statement that disinflation is over is likely a backward-looking comment on the progress from 10% inflation. However, the ECB’s own forward-looking forecasts project inflation will fall below its 2% target, suggesting that future rate cuts are more likely than the confident public rhetoric implies.
The market is pricing in approximately three more rate cuts for next year, totaling around 110 basis points. However, J.P. Morgan's analysis, supported by the Fed's own dot plot, suggests only one additional cut is likely, indicating that current market pricing for easing is too aggressive.
Robert Kaplan argues that with inflation at 2.75-3%, the neutral Fed funds rate is ~3.5-3.75%. Since the current rate is 3.75-4%, another cut would place policy at neutral, not accommodative. This is a risky position when inflation remains well above the 2% target, leaving no room for error.
The Federal Reserve’s recent policy shift is not a full-blown move to an expansionary stance. It's a 'recalibration' away from a restrictive policy focused solely on inflation toward a more neutral one that equally weighs the risks to both inflation and the labor market.
Despite nominal interest rates at zero for years, the 2010s economy saw stubbornly high unemployment and below-target inflation. This suggests monetary policy was restrictive relative to the era's very low "neutral rate" (R-star). The low R-star meant even zero percent rates were not stimulative enough, challenging the narrative of an "easy money" decade.
The Fed projects the unemployment rate will average 4.5% in Q4—a significant increase—yet it only forecasts one additional rate cut in 2026. This inconsistency suggests the Fed may be forced to deliver more cuts than currently communicated if its own unemployment scenario materializes.
The Federal Reserve's anticipated rate cuts are not a signal of an aggressive easing cycle but a move towards a neutral policy stance. The primary impact will be modest relief in interest-sensitive areas like housing, rather than sparking a broad consumer spending surge.
A surprisingly close 5-4 vote to hold rates reveals a deep split at the Bank of England. Governor Bailey is now the pivotal vote, and his stated data dependency and focus on downside economic risks will determine the timing of future cuts.