Will other central banks just follow the Fed?

Central bankers are still in data-dependent mode. The US Federal Reserve is looking for “greater confidence” on inflation, while the Bank of England’s (BoE) Monetary Policy Committee has pledged to “monitor closely indications of persistent inflationary pressures and resilience in the economy as a whole”. Just this week, the European Central Bank (ECB) said it would “continue to follow a data-dependent and meeting-by-meeting approach” to determining the path of interest rates.

But more cynical observers would argue that this focus on month-to-month figures is overblown: given that rate cuts are coming sooner or later, will central banks just follow the Fed?

Following the Fed 

One motivation for flocking together is on reputational grounds. Simon French, chief economist at Panmure Gordon, thinks that “never ones to be blind to their legacy, monetary policymakers may conclude that there is safety in numbers to avoid being singled out for a policy mistake as interest rates inflect”. The legacy of Jean-Claude Trichet perhaps looms here. The former ECB president had a tendency to zig when others zagged, most notably when raising interest rates in 2011 as a sovereign debt crisis engulfed southern Europe. Panmure Gordon’s French thinks that, since no one wants to be another Trichet, “when data-led policy comes into conflict with reputational risk, we think the latter triumphs”.

There could be another, more technical, attraction to following the Fed. If policymakers cut domestic interest rates while US rates are still high, they could trigger unfavourable exchange rate movements. Lower base rates lower demand for the domestic currency, causing a depreciation. This increases the relative price of imports, contributing to inflationary pressure – something that rate-setters sensitive to an inflationary resurgence will be at pains to avoid.

Or following the data? 

But this argument doesn’t look entirely convincing – at least not for the BoE and the ECB. Jennifer McKeown, chief global economist at Capital Economics, believes incoming domestic data will hold the most sway.

McKeown thinks that when it comes to the ECB, “there are no significant exchange rate concerns that should prevent it from acting alone”, adding that it has diverged from the Fed more recently. The BoE also has form, especially when it comes to tightening policy: UK policymakers started hiking months before the Fed in this cycle.

Matters might, admittedly, be more complicated for economies with closer ties to the US economy (such as Mexico), or those with dollar pegs (the Gulf states). But on the whole, the global picture seems to be one of central banks diverging, rather than moving in step. Emerging economies have seen a mixed bag of cuts and hikes, with the Turkish central bank hiking rates to 50 per cent in March as the Brazilian central bank cut rates for the sixth time.

The picture is varied in developed markets, too. Last month, the Bank of Japan increased rates for the first time in 17 years, bringing an end to years of negative interest rates. Only days later, the Swiss National Bank surprised markets when it cut its headline interest rate by a quarter of a percentage point. Bank of America analysts now think that rather than moving together, “monetary policy decisions are becoming gradually less synchronised”.

When it comes to the UK, Imogen Bachra, head of non-dollar rates at NatWest, said that “markets are placing too much weight on the bearing the Fed’s reaction function will have on the BoE, particularly in the immediate term”. Bachra expects domestic data, rather than US figures and Fed rhetoric, to drive the timing of cuts in the UK. As a result, she thinks that the BoE could be ready to kick things off as soon as June – regardless of the Fed’s decision the week before.

June rate-setting meetings