OECD: European Central Banks Should Keep High Interest Rates Until Spring 2025

European central banks may need to keep interest rates at high levels until 2025, which is much longer than financial markets expect, in order to protect against stubborn inflationary pressures, claims the Organisation for Economic Co-operation and Development (OECD).

In its latest economic forecasts, the OECD expects the European Central Bank to maintain its reference rate at the current level until spring 2025, while the Bank of England could keep rates until the end of that summer.

This would mean that they would maintain high rates longer than the U.S. Federal Reserve, which the OECD believes will start to reduce rates in the second half of next year.

The prospects for sticky inflation have come alongside softer growth outlooks amid tighter financial conditions, slower trade expansion, and declining business and consumer confidence.

Clare Lombardelli, chief economist at the OECD, told the Financial Times that the organization expects a ‘soft landing’ in major economies after central banks sharply raised rates, but added that ‘monetary policy will need to remain restrictive for some time’.

– We remain concerned about the persistence of inflation. Rates will need to stay high – stated Lombardelli.

Policymakers emphasize that it is too early to talk about rate cuts after many major central banks have put policy changes on hold this autumn. However, markets are questioning that message as growth slows and key inflation rates retreat, prompting investors to price in cuts as early as next summer.

Restrictive Policy

Expectations for earlier rate cuts in the U.S. rose this week after Christopher Waller, one of the Fed’s policymakers, signaled that it is unlikely rates will rise further and that they could be reduced if inflation continues to slow.

The OECD, which represents wealthy countries, warned in its outlook that the ‘full effects’ of cumulative tightening in recent years have yet to be felt. Monetary policy should remain restrictive until there are clear signs that underlying price pressures are ‘permanently easing’ and while short-term inflation expectations are falling.

The OECD stated that although there has been a reduction in the core inflation rate, which includes food and energy, more than half of the items in inflation baskets in the U.S., euro area, and the United Kingdom still show an annual inflation rate above four percent.

Lombardelli indicated that the Fed’s longer cycle of monetary tightening and persistent downward inflation in the U.S. will allow it to start cutting rates earlier than the ECB. Potential growth in the U.S. is also, she claims, greater than in the eurozone.

ECB President Christine Lagarde said this week that inflation in the eurozone is likely to rise again in the coming months and that ‘it is not time to start declaring victory’. Investors anticipate the first Fed and ECB cuts by June, followed by another two or three cuts during the remainder of 2024. The Bank of England is expected to start cutting rates somewhat later, at the earliest in August.

Weak Economic Growth

The OECD expects average inflation in G20 economies to decrease only gradually, falling from 6.2 percent this year to 5.8 percent in 2024 and 2.8 percent in 2025. They noted that there has been a particular slowdown in sectors sensitive to high interest rates, especially in housing markets and in economies reliant on bank financing, such as the eurozone.

According to all forecasts, global growth next year is expected to weaken to 2.7 percent, the slowest rate since the financial crisis (excluding the first year of the pandemic). Once inflation decreases, allowing for real income growth, the global economy is expected to record a growth of three percent in 2025, the OECD reported.

While interest rates in many countries will be ‘slightly restrictive’ next year as energy subsidies are gradually phased out, the OECD warned that many wealthy countries face ‘significant risks’ to their long-term fiscal sustainability without substantial efforts to rein in public debt.

Many countries are expected to record a primary budget deficit this year and next, indicating that it will be harder to reduce the debt ratio, the OECD noted.

It is also projected that growth in China, amid slow consumption growth and weakening activity in the struggling real estate sector, will slow to 4.7 percent next year from this year’s 5.2 percent. Ongoing ‘structural stresses’ in China have been one of the main negative risks to the outlook for global growth, the OECD explained.

– There is a clear risk that the real estate crisis could have a greater and more lasting impact on the Chinese economy than anticipated – they conclude.