Has the Fed and the ECB been behind the curve?

The Chair of the US Federal Reserve Jay Powell chose last month to retreat from the Fed’s aggressive bid to cool the world’s largest economy and reduced interest rates for the first time in four years.

The Federal Reserve reduced the target for its key lending rate by 0.5 percentage points, to the range of 4.75-5 per cent.

In the eurozone, European Central Bank President Christine Lagarde has given her strongest signal yet of another interest rate cut. The European Central Bank is increasingly confident that inflation will fall to its two per cent target, and this will be reflected in its next policy move.

"The latest developments strengthen our confidence that inflation will return to target in a timely manner," Lagarde told a European Union parliamentary hearing in Brussels. "We will take that into account in our next monetary policy meeting in October."

But have the two central banks waited too long to cut rates amid an increasingly worrying macro backdrop?

In response to this and other questions, including concerns about the considerable budget deficits most governments have run for the past several years, put to him by Reuters journalist Francesco Canepa, London Business School’s Professor Richard Portes said the following:

“Both the Fed and the ECB have been ‘behind the curve’ for some time now. The rate of inflation has turned negative in some eurozone countries and is below two per cent in all major Eurozone countries, even Germany, after hovering just above two per cent for several months.

“PCE inflation, the Fed’s preferred ‘headline’ measure, is not far above two per cent, and both the US and the Eurozone are showing signs of weakening output and employment growth. The Fed’s ‘dual mandate’ has already shifted its focus towards growth, and even inflation hawks in the ECB are finally voicing concerns about the eurozone’s weak economic performance.

“Barring some nasty shock, such as a war-induced spike in oil prices, lags will continue to bring inflation down even with monetary policy easing. Fiscal deficits are indeed a problem in the US and several Eurozone countries, France, in particular), although the burst of inflation brought debt to GDP ratios down. But that is not an issue for monetary policymakers, except as observers – and insofar as they see governments make progress in bringing deficits down, that’s a reason for monetary easing."