- Three central bank decisions awaited as tariff reality sets in
- Fed set to go on pause, ECB and BoC to likely cut again
- But US GDP and PCE inflation could steal the limelight
- Australian CPI and China PMIs also on tap
Fed to pause rate cuts as Trump 2.0 begins
The central bank agenda will be jam-packed next week as the first round of policy meetings of 2025 heats up. The Federal Reserve will be at the focal point of all the action as it’s expected not to follow the European Central Bank and Bank of Canada in cutting interest rates.
A resilient US economy and sticky price pressures have left the Fed little room to lower borrowing costs even before President Trump and a Republican-led Congress have had a chance to enact their low taxes, high tariffs policy cocktail. Chair Powell has been keen to stress that the Fed is not on a preset course, leaving the door open to rate increases should the new administration’s policies push inflation higher.
However, in the more immediate term, the inflation picture has become somewhat more favourable, and the trend could turn downwards again in the first few months of 2025. One of the Fed’s more influential governors, Christopher Waller, recently flagged the possibility of rate cuts in the first half of this year, as markets at one point had priced in fewer than 30-basis-points reduction by year-end.
Yet, the pullback in the US dollar following Waller’s comments was fairly mild and only picked up pace on the back of the tariffs headlines when Trump signalled his intention to go easy on China before trade negotiations have taken place. This highlights how tariffs have once again become a key driver of Fed policy expectations.
Should the Fed on Wednesday decide to keep rates unchanged but strike a less hawkish tone than what investors are anticipating by suggesting that a cut is likely in the next few months if inflation resumes its decline, the market reaction may be limited if the Trump newsflow isn’t as positive.
Bar is set high for a Dollar correction
But Trump and the Fed aren’t the only things traders will be keeping an eye on. Thursday will see the release of the advance reading of GDP in the final three months of 2024. The US economy is projected to have expanded by an annualized rate of 2.6% q/q versus 3.1% in the prior quarter. A stronger print than this could counter any unexpected dovishness by the Fed.
Similarly, Friday’s PCE inflation numbers and personal income and spending data will be just as crucial in shaping rate cut expectations. The core PCE price index, which the Fed monitors closely, is estimated to have stayed unchanged at 2.8% y/y in December according to the Cleveland Fed Nowcast, with headline PCE accelerating to 2.6% y/y.
Other releases will include new homes sales on Monday, durable goods orders and the consumer confidence index for January on Tuesday, pending home sales on Thursday, and the Chicago PMI on Friday.
Overall, any renewed optimism that the Fed might express about the inflation outlook is unlikely to produce much of a dent in the dollar until it’s reflected in the data and Trump doesn’t flip-flop on his softened stance towards China.
Will the BoC turn less dovish?
Ahead of the Fed’s decision, it will be the Bank of Canada’s turn to set policy a few hours earlier on Wednesday. The Bank of Canada has slashed interest rates more aggressively than any other major central bank during this easing cycle. The latest CPI data showed a dip in headline inflation to 1.8% y/y in December and a slight moderation in core measures too, paving the way for a further 25-bps cut at the January meeting.
However, investors have priced in just one additional cut after that and the BoC may soon join the Fed in pausing. This hasn’t provided much of a reprieve to the Canadian dollar, which is languishing near five-year lows against its US counterpart. Even if the BoC were to indicate that its rate-cutting cycle is nearing the end, political uncertainty following the resignation of Prime Minister Justin Trudeau and the threat of 25% tariffs on all Canadian imports into the US by Trump are hanging over the economy.
Hence, the BoC will probably prefer to keep its options open and merely signal a slower pace of easing going forward than a pause, which will not do the loonie any favours. But there could be some support for the currency from Thursday’s wage growth figures and Friday’s monthly GDP reading.
ECB to stick to gradual approach
The ECB has been steadily trimming rates since June 2024 and is widely expected to maintain a similar pace in 2025, with President Lagarde reinforcing this gradual approach in remarks at Davos this week. The current market pricing suggests one 25-bps cut per quarter. But for the January meeting, a small fraction of investors is betting on a larger 50-bps cut.
A larger move is highly unlikely, though, given that services inflation in the Eurozone is still hovering around 4% and a closely watched gauge of wage growth climbed to a more than three-decade high in the third quarter of last year.
On the flip side of this argument are the mounting worries about growth in the euro area amid the political turmoil in France and Germany, the drag on exports from China’s sluggish economy and now, the possibility of new import levies by America if Trump gets his way.
Still, the gloomy outlook isn’t dire enough to warrant faster reductions just yet and the risk of any surprises at Thursday’s meeting is quite low. The ECB is almost certain to cut rates by 25 bps and Lagarde will probably stick to her recent script, with investors hunting for fresh clues about any policy divisions within the Governing Council and on where policymakers see the neutral rate to be.
The euro could come under pressure if Lagarde refuses to rule out a more aggressive pace in the future, but a potentially bigger risk is new developments on the tariffs front, should Trump make any comments regarding trade restrictions with the EU.
There might be some reaction too on Thursday to the preliminary Eurozone GDP estimates for Q4.
Yen unimpressed by hawkish BoJ bets
The yen has been somewhat steadier lately, finding support from rate hike expectations by the Bank of Japan as well as safety flows from the Trump-related uncertainty. The Bank of Japan upped its policy rate to 0.5% on Friday – the highest since 2008. The yield on 10-year Japanese government bond yields is also at more than decade highs.
Yet the yen hasn’t been able to stage much of a bounce back against the dollar, partly reflecting the still huge policy divergence between the Fed and the BoJ. Next week’s data might help close the gap if the January CPI figures for the Tokyo district, due on Friday, boost the odds of further rate hikes by the BoJ.
Services PPI on Tuesday and industrial output on Friday might also attract some attention.
Aussie eyes domestic CPI and China PMIs
Staying in Asia, China will publish its manufacturing PMI for January on Monday, which will be followed by the Caixin/S&P Global equivalent on Friday. Any signs of strengthening activity in China’s massive manufacturing base could add to the recent improved optimism about the recovery, lifting the risk-sensitive Australian dollar.
But for aussie traders, the main highlight will be Wednesday’s CPI report out of Australia. The Reserve Bank of Australia is edging closer to delivering its first rate cut so a soft report could fuel expectations that policymakers will lower rates as early as the next meeting in February. This could jeopardize the aussie’s recovery from near five-year lows against the greenback.
