OECD says markets wrong on interest rate cuts

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The OECD has warned that inflation could force central banks in western Europe to keep interest rates higher next year than financial markets expect, despite some of the weakest global growth rates since the financial crisis.

In its latest economic outlook, the Paris-based organisation said it expected the European Central Bank and the Bank of England to hold benchmark rates at their current peaks until 2025 — much longer than the markets are expecting — because of persistent inflationary pressures.

That contrasts with the US Federal Reserve, which it expects to start cutting rates in the second half of next year. 

The OECD also said growth in the world economy would weaken to 2.7 per cent next year — the most sluggish rate since the financial crisis except for the first year of the pandemic.

The outlook reflects tighter financial conditions, as central banks seek to drive down inflation, as well as slower trade growth and ebbing business and consumer confidence, the organisation said.  

The OECD forecast that global growth would tick up to 3 per cent in 2025, as price rises slow and real income grow.

It expects the US to grow 1.5 per cent next year and 1.7 per cent in 2025 — far quicker than Europe’s major economies.

The organisation also projects that the UK economy will expand 0.7 per cent next year and 1.2 per cent in 2025, with Italy recording similar rates. Germany is forecast to perform slightly worse, with 0.6 per cent growth in 2024 and 1.2 per cent the year after.

Bar chart of Annual GDP growth forecasts, %  showing G7 countries face a sluggish growth outlook

Clare Lombardelli, OECD chief economist, said that, while the organisation expected a “soft landing”, it was too soon to cut borrowing costs.

“Monetary policy is going to have to remain restrictive for a period of time — we are still worried about inflation persistence,” she told the Financial Times. “You are going to need real rates to be high.”

The OECD forecast that average inflation in the G20 economies will ease only gradually, falling to 5.8 per cent in 2024 and 3.8 per cent in 2025, compared with 6.2 per cent in 2023. 

Senior policymakers in the US and Europe have argued that talk of rate cuts is premature, but markets have been hard to convince, as growth slows and headline inflation rates retreat. Investors are now pricing in Fed rate cuts as soon as May 2024 and reductions in eurozone borrowing costs in April.

Line chart of policy rates in selected economies (%) showing central banks are forecast to hold back before cutting rates

Investors increased their bets on near-term rate cuts in the US this week, after Christopher Waller, one of the Fed’s most hawkish policymakers, signalled that borrowing costs were unlikely to rise further and could be cut if inflation continued to slow.

But the OECD warned the “full effects” of the tightening over the past two years had yet to be felt. It added that cuts could only come after clear signs that underlying price pressures were being “durably lowered” and as short-term inflation expectations fell. 

The organisation said that while there had been falls in core inflation, which excludes food and energy, more than half of the items in inflation baskets in the US, the euro area and the UK still showed annual rates above 4 per cent. 

Lombardelli said the US would be able to lower interest rates before the ECB because the Fed had started raising rates sooner and more aggressively. 

Christine Lagarde, ECB president, warned this week that eurozone inflation was likely to rise again in the coming months and that now was “not the time to start declaring victory”.

The OECD also warned that many rich countries faced “sizeable risks” to their long-run fiscal sustainability without more significant efforts to rein in public borrowing.

Many of them were set to record primary budget deficits this year and next, indicating it would be harder to lower debt ratios, the OECD added.

It added that “structural stresses” in China were a downside risk to global growth. Citing slow consumption growth and weakening activity in the country’s struggling real estate sector, the OECD forecast that Chinese growth would slow to 4.7 per cent in 2024 from 5.2 per this year.

“There is a clear risk that the property crisis could have a larger and longer-lasting impact on the Chinese economy than projected,” the OECD said.

Additional reporting by Martin Arnold in Frankfurt

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