Jim Power: Interest rate cuts are coming, but by how much and when are pressing issues

A re-evaluation is underway of whether central banks, including the European Central Bank, will aggressively cut rates this year, writes Jim Power

A re-evaluation of whether the European Central Bank will aggressively cut rates is underway. Picture: AP

One of the key features of the world of finance in recent months was a sense of euphoria as headline inflation almost everywhere fell faster than expected, which led to the typically irrational financial markets to price in aggressive easing in interest rates this year, with the cuts thought likely to commence sooner rather than later.

This resulted in a very buoyant global stock markets in most places and a sharp decline in government borrowing costs, or bond yields.

Indeed, the S&P 500, the US index, ended the year up over 24%, its third-best performance in the past decade, while the tech-dominated Nasdaq ended the year up almost 54%, with some of the big names such as Amazon, Meta, and Apple delivering a stellar performance. The final weeks of the year made a significant contribution to those stock market gains.

The overall performance of equity and bond markets in the final weeks of the year felt a bit like a bubble. And alas, in the early days of the new year that bubble has been pricked and, as is their wont, markets are now moving to readjust their premature enthusiasm.

We are witnessing a new year hangover of sorts.

There is an element of profit taking from investors after strong gains, but the heightened risks in the Middle East and the Japanese earthquake have also contributed.

A re-evaluation of what central banks might do, including the European Central Bank, and particularly how quickly and how aggressively they might do it, is also underway.

This follows the publication of less-than-impressive inflation data. German inflation jumped to 3.7% in December, French inflation jumped to 4.1%, and the eurozone-wide inflation rate went up to 2.9%.

A reduction in government subsidies on food, gas, and electricity was partly responsible for the spike.

And it was never likely to be the case that inflation would continue to come down in a straight line: Having decelerated so markedly and so relatively quickly, the downward momentum was inevitably going to be choppier. 

A more cautious approach from central bankers looks likely. Having fought so hard and so aggressively to bring inflation under control, they will need to be convinced that the war is really won before moving.

Against a background of very obviously weak economic performance in the eurozone and the UK in particular, interest rates will come down everywhere in 2024, but it may not just be as quick as the markets believed.

At the start of 2023, the debate was centred on how high interest rates would have to go to bring inflation under control, and at what economic cost. At the beginning of 2024, the debate is about how quickly and how aggressively central bankers will move to cut rates.

Here in Ireland, the exchequer news was strong, but the Department of Finance appears to be falling over itself to curb enthusiasm.

I guess this should be expected as we move into a key election period. The department would not want the parties of Government or
indeed of opposition to get carried away.

In 2023, the exchequer ran a surplus of €1.2bn, down from a surplus of €5bn in 2022, because of the sensible transfer of €4bn to the National Reserve Fund.

The Department of Finance said that if the one-off revenue gains are excluded, there was an underlying deficit of around €6.5bn.

Despite these caveats, the strength of tax revenues is clear proof of the resilience and strength of the economy last year. Tax receipts of €88.1bn were up by €5bn from 2022. Caution is now advisable, but the underlying story is still compelling.