Why Now? Expert Analysis of Central Banks’ Rate Cuts
Interest rate cuts are being considered by central banks worldwide, or they have already begun in the current economic environment. This choice is not without dispute, as some contend that such actions could worsen already existing economic issues or fail to stop a recession.
TS Lombard experts, however, contend that there are strong arguments in favour of rate decreases and that the central banks’ strategy should be seen more favourably.
It is a myth that rate increases had no appreciable effect on the economy. Interest-sensitive industries were almost immediately impacted by interest rate rises. For example, demand for durable goods slowed dramatically, real estate investments halted, and housing demand fell precipitously.
In particular, the global construction industry had difficulties, but one that was partially mitigated by projects started during the COVID-19 epidemic, when shortages of supplies were common.
Rate increases first became apparent through “flow” effects, which show sudden shifts in credit demand and investment. The “stock” impacts, on the other hand, related to the influence on the disposable incomes of debtors, changed more slowly.
The reason for the lack of activity in this area during the most recent tightening cycle is that both corporations and households have restructured their obligations, which prevented serious financial distress even in the face of increased debt servicing costs.
Rate reductions have the ability to quickly boost the economy. Rate-sensitive demand could rise quickly, according to TS Lombard, which will boost demand for housing and stimulate building.
Reduced rates may also stimulate the durable goods industry, so enhancing worldwide production. More importantly, a change in monetary policy at this time might stop conditions from getting tighter because of the effects of prior rate hikes on stocks.
Monetary policy is expected to tighten further in the absence of any quick rate decreases as the accumulation of the impacts of earlier rate hikes continues. The possibility of further economic activity contraction in this scenario strengthens the argument in favour of preemptive rate decreases.
Rate cuts’ impact on asset values is mostly dependent on the environment in which they are applied. Preemptive rate reductions, intended to avert future recessions, frequently boost risky assets. These reductions imply that central banks are taking the initiative and prioritising economic stability. As a result, asset prices usually rise as investor sentiment does.
Reactive rate reductions, on the other hand, which are implemented in reaction to current economic difficulties, may have more complicated effects. Although their goal is to boost the economy, they might also be a sign of a worsening situation, which could lower asset prices and investor confidence.
The general consensus early in the year was that risk assets were being supported by central banks taking a proactive stance. But uncertainty was raised when inflation spiked after that.
TS Lombard notes that despite worries, there aren’t any clear indications of a serious slowdown in the labour markets just yet. The fact that employment numbers are still largely stable shows that central banks might not be too far behind the times just yet.
In the past, central banks have delayed making policy changes until they saw more obvious indications of economic distress, such as the Federal Reserve under Alan Greenspan in 1995. In this situation, a soft landing could be tough, but given the state of the economy right now, it is hard to see anything worse than a slight recession.
