Europe to cut interest rates sooner than US as more divergence in monetary policy loosening likely

By Nuran Erkul

LONDON (AA) - The euro area is expected to see interest rate cuts sooner than the US this year, reflecting the relative strength of the economies, said the chief economist of the Organization for Economic Cooperation and Development (OECD), noting that more divergence of monetary policy across economies on the loosening side is likely.

The OECD projects that interest rates in advanced economies will begin to come down starting from the second half of this year as inflation falls, Clare Lombardelli told Anadolu in an exclusive interview as the OECD is releasing its Economic Outlook.

"We expect the rate cuts in the euro area in the third quarter of this year, but that might be brought forward depending on the (inflation) data. We are projecting rate cuts in the euro area both in the third and last quarter," she said. "They may choose to make one or two, or they may choose to go a bit faster than that. But we are certain that by the end of 2025, we think policy rates in the euro area will have been reduced considerably from the numbers that we have seen now."

The European Central Bank's (ECB) interest rate on the main refinancing operations, on the marginal lending facility and the deposit facility have remained unchanged at 4.5%, 4.75% and 4% respectively since September 2023.

The US Federal Reserve is expected to start interest rate cuts "sort of third quarter or maybe later," according to Lombardelli, as the decision depends on how the inflation data will evolve over the coming months amid the strength the US economy shows.

The Fed said Wednesday that it is keeping the federal funds rate in a range of 5.25% to 5.5%, the same level it has held since its July 2023 meeting.

"We at the moment have two cuts penciled in for this year, but that will depend very much on the data. We might see more divergence of monetary policy across economies on the loosening side, as it all depends on inflation continuing. If inflation does not fall as expected, these rate cuts may have to be delayed slightly," she said, noting that the position of the US will be important to lots of countries because of the impact on the dollar exchange rate.

Lombardelli said Canada could be another example for a rate cut starting in the third quarter while an opposite move is expected from Japan with "a very gradual rise in policy rates.”

The Bank of Japan (BoJ) raised its short-term interest rates in March this year to 0%-0.1%, ending the country’s 17 years of negative interest rates. The BoJ has become the last central bank to drop the negative interest rate policy.

"In the second half of this year, they may choose to tighten rates further and more in 2025," she said.

Lombardelli also noted that China is in a slightly different position too, with more weaknesses in the economy, and the country might take a different approach to monetary policy.

The People's Bank of China (PBoC) kept one-year and five-year loan prime rates unchanged at 3.45% and 3.95% respectively at its April 2024 meeting. The PBoC has lowered the one-year rate from 3.55% in August 2023 and has been keeping the rate at the same level for the last eight monetary policy meetings.

- Global GDP to grow 3.1% this year

In its Economic Outlook, the OECD projects the global economy to grow by 3.1% this year, unchanged from 2023, before it edges up to 3.2% in 2025, supported by stronger real income growth and lower policy interest rates.

"We have revised our growth forecast up this year to 3.1% (compared to the OECD's forecast in November). One of the drivers is that we have seen inflation fall faster than initially expected. That means people's real incomes are stronger than we thought and there is more strength to consumption," Lombardelli said, adding that stronger-than-anticipated labor markets are also among the drivers of upward revision to the forecast.

The US emerges as an exception with 2.5% growth in 2023 and with 2.6% growth this year, showing a strong difference from the advanced economies of Europe.

"The euro area had a very difficult 2023 and a number of economies, including Germany, were in a recession last year. There are obviously risks. But looking forward, we do not expect a recession in any European economy. We expect the outlook to get better for European economies," she said.

Following 0.5% growth in 2023, the euro area’s GDP is projected to grow by 0.7% and 1.5% this year and in 2025.

"Obviously, that is a lot less than what we are forecasting for the US. There is a strong difference between the US particularly and the European economies' growth both for 2023 and for this year. However, we expect this difference to narrow going forward," Lombardelli noted.

The divergence across economies is expected to remain in the near term but fade as the recovery in Europe becomes more firmly based and growth moderates in the US, India and several other emerging-market economies, the OECD said in its Economic Outlook.

Annual inflation in the G20 economies is expected to go down gradually, declining to 3.6% in 2025 from 5.9% in 2024, according to the outlook. By the end of 2025, inflation is expected to be back on target in most major economies, which is around 2%.

- Tight monetary policy needs to be maintained in Türkiye ‘well into 2025’

Lombardelli, on Türkiye's shift to orthodox economy policies, said the monetary and fiscal policy changes in the country are very welcome as they are "exactly what the economy needs, given the huge challenge of inflation.”

"Inflation is still high in Türkiye, but we are expecting it to come down," she said.

According to the OECD's outlook, inflation is expected to be 55.5% and 28.9% this year and in 2025, respectively in Türkiye.

Real GDP growth is projected to slow from 4.5% last year to 3.4% this year and to 3.2% in 2025.

"Tighter financial conditions and the adverse impact of inflation on purchasing power will subdue household consumption," said in the report.

Earthquake-related reconstruction expenditures are pushing up demand as investment is needed, according to the OECD.

Lombardelli said she expects Türkiye's exports to rise as the global economy picks up.

"So we have some reasons for optimism for the Turkish economy, but the tight policy will need to continue as long as it takes to bring inflation down. We are projecting that the 50% policy rate will need to be maintained throughout the rest of this year and well into the next year, possibly by the second quarter of 2025," she said. "We need that tight monetary policy to make sure inflation expectations remain well anchored."

She said she does not expect policy relaxation, noting that it takes time for these tighter policies to feed through the economy and bring down the inflation.

"We may see some loosening on monetary policy if inflation comes down in Türkiye, but for the foreseeable future, it is right to keep this monetary stance and keeping an eye on whether it needs to be tightened," Lombardelli said.