Delivering the first cuts in interest rates since the early days of the pandemic was the easy part. The coming year is likely to be rich in nuance: Inflation won’t scale the heights of 2022, but officials are skeptical it will return to the ultra-low levels that prevailed before the pandemic. That means borrowing costs will retreat in most economies, though not aggressively, and without many declarations of victory.
For the authorities that have yet to trim, such as the reserve banks in Australia and India, watch for a reduction in the next few months. They can still keep policy restrictive — an ill-defined region that holds the economy back — and bring rates down a little. China, wrestling with a dour outlook and the specter of deflation, has been cautiously easing for a while. The risk is that Beijing does too little rather than too much.
Here are some things to consider:
The market isn’t (quite) everything
It’s fashionable in some financial precincts to disregard what central bankers profess. Markets are right, according to this philosophy, and officials are always a step or two behind. But it’s worth listening carefully to how the people making the decisions view the world. The experience of 2024 bears this out: Back in January, markets predicted as many as six cuts by the Federal Reserve, worth about 175 basis points. The Federal Open Market Committee itself was more circumspect and delivered three cuts. So while it’s tempting to pooh-pooh insiders as being too cautious, or alternately, too reckless, what they articulate does really matter. Don’t be so quick to discard it.
Beyond data dependency
It’s fine to be attentive to data — we wouldn’t want officials to ignore indicators of economic health. That’s different from being the prisoner of data, especially on a monthly basis. Reluctance to go out on a limb lest a particular report makes you look a little silly has gotten in the way of projecting an overall strategy. If there’s a good story to tell, officials should tell it. If they don’t, someone else will, and it’s likely to be unattractive. Too often, hints about the outcome of the next few policy meetings are crowded out by caveats, such as the need to get through the following month’s reports on jobs and prices. That’s understandable, but gets in the way of a broader narrative. It puts too much emphasis on the short term, and not enough on the medium to long run.
Bring forward guidance in from the cold
Once seen as an integral part of successful policymaking, the art of telling investors what you will do before you do it has fallen out of favor. It was a casualty of the post-Covid price spike, along with the use of words like “transitory.” Having been caught off guard by inflation’s surge a few years ago, and enduring no small degree of public opprobrium as a result, officials became reluctant to look too far into the future. But as increases in the cost of living return to something like normal, it’s time to consider re-embracing forward guidance. For a long time, it worked. The idea was to give investors confidence in the likely rate path and minimize market disruptions when shifts did occur. It’s worth giving such counsel another shot.
