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The global battle against inflation is entering a new phase. After price pressures dropped steeply last year, central banks in advanced economies began slashing interest rates in earnest this summer. But pulling inflation back to its 2 per cent target, persistently, has proved difficult. As the year-end approaches, fresh inflationary threats are on the horizon, and the future path of interest rates is becoming more uncertain.
On Wednesday, the US Federal Reserve cut rates by 25 basis points, but gave traders a reality check with its forecasts. Investors had been expecting a continued normalisation of interest rates and inflation next year. The committee’s “dot plot” of rate projections for 2025, however, showed fewer cuts than in forecasts made before the US election. Estimates for inflation were also nudged higher. The news ended the S&P 500’s relentless upward rise this year.
The “last mile” of inflation has been a particular bugbear for the Fed. Its preferred measure of inflation, annual core personal consumption expenditure, has slowly edged higher after dropping to 2.6 per cent in June. But the uptick itself is not too concerning. It has been driven by economic resilience and high housing-related inflation, which tends to lag behind other components and is now easing. At 4.25 to 4.5 per cent the policy rate remains relatively restrictive too. The bigger concern is what new price pressures may be coming ahead.
Donald Trump’s election victory changes the Fed’s calculus. Significant elements of his agenda, including tariffs on US trade partners, slashing taxes and cutting immigration, will bring inflationary pressures. The president-elect’s weaponisation of uncertainty, particularly on trade, makes it difficult to know how and to what extent he will implement his plans. The risk of an impending government shutdown in recent days hasn’t helped either. Fed chair Jay Powell admitted that committee members had begun to consider the impact of Trump in their projections.
The president-elect’s agenda is also consequential for other central bank outlooks. In the UK, the Bank of England said trade uncertainty had risen “materially” as the central bank held rates on Thursday. But the UK’s near-term inflation trajectory is complicated more by domestic factors. After dropping below 2 per cent in September, annual price growth is back up to 2.6 per cent. The Autumn Budget — which included tax rises and an increase in the minimum wage — will add to business costs. That said, weakness in business activity could offset some price pressures. Low-quality labour market data has clouded rate-setting too.
The European Central Bank is bucking the trend. Its president, Christine Lagarde, was in celebratory mood this week, declaring that the “darkest days” of high inflation are behind the Eurozone. The ECB cut rates by 25 bps this month, and signalled further cuts in the new year. Indeed, inflation has been tame, hovering close to 2 per cent.
The eurozone’s challenge is the broad weakness in its economy, which would dampen further if Trump followed through on his tariff-raising rhetoric. On Friday, via social media, the president-elect threatened levies on the bloc if it fails to buy American oil and gas in bulk. The trajectory of fiscal policy is also unclear, with political instability in France and Germany affecting tax and spending plans.
While the climb in interest rates was largely smooth and co-ordinated, the cutting cycle is shaping up to be punctuated by plateaus and characterised by divergence. Central bankers are due some credit for seeing off the worst of the global 2021-2022 inflation shock. But now matters closer to home and the uncertain and varied economic impacts of Trump 2.0 are weighing more on their minds. The job of central bankers, Powell more than most, will not get easier in 2025.