The US Federal Reserve's supersized rate cut in September is likely to encourage central bankers in other economies to start or continue rate-cutting cycles through the end of 2024.

The Fed’s 50-basis-point cut followed other rate reductions in Europe, the UK, Canada and elsewhere this year. Economies are navigating how to unwind tighter monetary policy as inflation recedes from the pandemic-era highs sparked by supply-chain bottlenecks, geopolitics and the unleashing of pent-up consumer demand.

A cut by the Fed and the related pullback in the dollar from recent highs leave more room for other economies to reduce rates further. While some variance is expected, global rates will continue to trend lower for years to come.

"These really are the first steps toward creating the conditions for the post-pandemic economy," Joe Brusuelas, chief economist and principal with RSM US, said in an interview. "We had the price shock followed by the rate shock, followed by the return of price stability. Now, the central banks are moving to reset policy rates back towards their respective levels of neutral."

Comparing pace of cuts

The European Central Bank led its US and UK counterparts this year, with two cuts since June to take its benchmark rate to 3.5% from 4.0%. The Bank of England followed in August with a rate cut to 5.0% from 5.25%. Fed officials' most recent median projections in September now target the longer-run federal funds rate at 2.9%, up from 2.5% projected at the end of 2023.

Many economic experts have pondered whether the US was late in issuing its first interest rate cut, especially after weak employment figures were released in August and payroll estimates for the 12 months through March 2024 were revised down by over 800,000 jobs. However, the US economy has remained strong, with resilient consumer spending and GDP increasing at an annual rate of 3% in the second quarter, according to the most recent estimate from the US Bureau of Economic Analysis.

"There continues to be a hot debate about the pace of rate cuts, and we'll only be able to evaluate them in hindsight, but the US economy has been in many ways more resilient than other countries," said Tara Sinclair, director of the GW Center for Economic Research at The George Washington University and former deputy assistant secretary for macroeconomics in the Office of Economic Policy at the Department of Treasury from 2022 to 2024.

"Recent cooling trends in the labor market and the improvements in inflation led me to argue for a 25 basis point cut in July," Sinclair said. "I don't think the Fed is too far behind, but they can start being less restrictive as inflation cools."

Following the Fed's September decision, the global economy is likely nearing a synchronized rate-cutting cycle with further action from the central banks of the eurozone, Canada and the UK, Brusuelas said. This will likely trigger the central banks of India and Australia to begin lowering their respective rates. India's rate of 6.5% is the country's highest since 2019, while Australia's 4.35% is its highest rate in over a decade.

Different situations

Among the G7 countries, the eurozone has had to act more swiftly this year with monetary policy in response to the economic needs of its various constituents, although certain countries such as Germany may have benefited from an earlier rate cut, said Byron Gangnes, professor emeritus of economics and senior research fellow of the University of Hawaii.

Meanwhile, Canada has been the most aggressive among the G7 nations, with three rate cuts this year as it is more vulnerable to higher interest rates due to factors such as the prevalence of a 15-year mortgage rather than a 30-year mortgage, Gangnes said.

Major exporter Japan, in contrast to its G7 peers, has entered a rate hiking cycle this year after decades of 0% interest rates and low inflation. While these conditions had encouraged investors to borrow yen and invest elsewhere — a process known as a carry trade — that practice is now unwinding as the yen strengthens against the US dollar.

Outside of the G7, China has eased its medium-term lending facility rate eight times since 2020, including two cuts this year.

"They have their own unique set of economic problems," Brusuelas said. "China is caught in a balance sheet recession, or an extended period of slow growth caused by debt and deleveraging."

Impact on foreign exchange

Foreign currency exchange may be a driver that pushes other countries to follow the Fed's September rate cut, George Washington's Sinclair said. The dollar tends to rise as the federal funds rate does, while lower rates can lead to the greenback weakening against other currencies.

"Lower interest rates in other countries compared to the US tend to depress their exchange rates and put pressure on prices of goods priced in dollars, notably oil," Sinclair said.

The strength of the dollar affects the spending power of US residents when traveling overseas. It can also influence the price of imports and exports and affect overseas earnings for domestic companies.

The relationship between the US dollar and Japan's yen will be one of the key points of focus as exchange rates are disrupted by interest rate policy. Central banks may not specifically target exchange rate concerns when deciding policy, but the issue is still likely to factor in to some degree, Gangnes said.

"Even if you don't target that rate, if you worry about the implications of a strong dollar on your economy, then you do have to think about whether or not a rate cut is going to be needed simply to keep in line with other countries where people can put their money," Gangnes said.