Will interest rates be cut this year?

So, in theory, higher interest rates reverse both the monetarist and Keynesian interpretations of why inflation rose, and inflation should fall this year, bringing forward the period when rates can start to be cut in order to deal with the recessionary conditions in the economy.

However, Gilles Moec, group chief economist at Axa, says it is not that simple, at least not for economies outside the US. 

He says the first issue is that there is a six or nine-month lag between a monetary policy action happening and it impacting inflation.

Moec (pictured) says: “The inflation we are getting now is really the result of the monetary policy of nine months ago. In many ways the US Federal Reserve has the simplest task. The inflation in the US is almost completely the result of the Keynesian stimulus in the economy causing excess demand.”

He continues: “They didn’t really have higher energy prices or supply chain issues; they did have a population with pockets full of stimulus money when lockdowns ended.

“Putting interest rates up reduces the amount of money in their pockets and so reduces demand. But the challenge they have is to prevent second order impacts in the economy — that is, from wage rises. And the thing they will be monitoring is the labour market.

“The US basically has full employment now, and there is always a risk that when you have that, wages rise, causing a wage price spiral. That is why I think they will be cautious and not cut rates this year, despite inflation starting to fall.”

I think interest rates should plateau soon and not be cut. Instead, they should stay at the same level, and potentially rise in future Gerard Lyons, Netwealth

Oliver Blackbourn, portfolio manager at Janus Henderson, says the Federal Reserve has a number of different mandates it must consider when setting monetary policy, and that so far it has focused on reducing inflation. 

But as recession takes hold and unemployment rises, it would have to consider looser monetary policy in order to fulfil the part of its mandate that is to ensure full employment.

The picture in the UK and Europe is more complicated 

Meanwhile, Moec says that while it is simple to understand the inflationary picture in the US, he feels in Europe and the UK it is more complicated.

He says: “The inflation in Europe is not caused by excess demand, it is the result of supply chain issues and higher energy prices. And frankly, the European Central Bank can put rates up to 50 per cent but the inflation [that is] caused by higher energy prices wouldn’t come down.