This short note aims to decipher a striking chart related to current economic events. As central banks in developed economies continue their cycle of rate cuts, this Killer Chart highlights the uneven transmission of key rate cuts to long-term rates within these economies.
Download the PDF: killer-chart-transmission-rates.pdf
Why is this interesting?
Central bank policy rates are vectors for monetary policy transmission and serve as a benchmark for all interest rate calculations, thereby determining financing conditions within economies. Changes in key interest rates have a direct impact on short-term interest rates (e.g., sovereign bond yields with maturities of less than one year), which in turn influence long-term interest rates, in line with the term structure of the yield curve[2].
Between 2022 and the end of 2023, inflationary pressures led central banks to tighten their financing conditions, which automatically caused a more or less proportional rise in long-term rates, as reflected in the increase in 10-year sovereign bond yields (see yellow dots in the chart above). Since the second quarter of 2024, developed economies have been entering a new slow cycle of easing financing conditions, which in principle should lead to a fall in long-term rates (see the blue dots on the chart opposite). However, this is not the case for the United Kingdom and France (circled in red in the chart opposite), while other countries (Germany, Belgium, United States) are only benefiting from a limited reduction in long-term rates at this stage.
This phenomenon suggests that the new cycle of rate cuts could prove particularly long, depending in particular on macroeconomic parameters (inflation and growth). As such, the monetary policy choices of the major central banks will be closely scrutinized. This phenomenon could also be uneven, with more limited effects on long-term rates depending on the country, i.e., weaker transmission of the decline in key rates, to the detriment of financing for the economy.
What should we make of this?
While it is difficult at this stage to draw conclusions from these initial observations, they nevertheless constitute warning signs for certain countries and highlight vulnerabilities.
Firstly, it should be noted that the transmission of lower interest rates appears to be working « correctly » in several economies (the blue dots on the far left of the graph): Denmark, Greece, Sweden, and Switzerland, for example. This is reassuring, suggesting that the spread of low interest rates continues to work and that economies that are not benefiting, or benefiting only slightly, are more the exception than the rule.
The case of France seems particularly ambiguous. Despite the emergence of political risk during the summer of 2024 (delay in appointing a Prime Minister after early elections in June-July), France benefited from a kind of reprieve or « grace period » during which the country did not experience an increase in its sovereign bond yields. However, the trend has reversed since September 2024, when difficulties in approving a budget for 2025, against a backdrop of a very large public deficit, created uncertainty and are now being penalized by rising long-term rates.
However, given France’s economic weight in the eurozone, a deterioration in French sovereign risk and/or its perception presents a risk of contagion, which could potentially lead to higher sovereign yields for eurozone countries with significant levels of public debt (Belgium and Italy, for example). This would be all the more true in a context where the growth outlook for the eurozone appears mixed.
The perception of sovereign risk is also a key concern in the United Kingdom, where the government’s ability to reconcile stimulating growth potential with preserving public finances is being questioned.
While political and fiscal risks will play a key role in 2025 in determining whether or not the cuts in key interest rates are effectively passed on to long-term rates, other issues also offer a significant degree of uncertainty. Among these, trade tensions are a growing threat, with higher tariffs, especially in the United States, likely to trigger a global protectionist spiral. Such a spiral would have negative short-term effects on trade volumes, effectively affecting countries that are highly integrated into international value chains (Germany and the Netherlands, for example).
Furthermore, protectionism will tend to raise the prices of imported goods and services and is therefore likely to be inflationary. In addition, in the United States, the announcement of major fiscal stimulus measures by the new President Donald Trump raises questions about the trajectory of inflation. The financing of future US public deficits also raises questions[4] and tends to generate some pressure on sovereign yields.
The room for maneuver of developed economies has been tested by the succession of crises in recent years. More than ever, an easing of financing conditions by central banks would provide some relief. However, uncertainty surrounding persistently higher inflationary pressures in certain countries (particularly in the United States with the announcement of Donald Trump’s economic policies) could well dash hopes of a rapid decline in key interest rates.
Furthermore, the perception of increased risks (political, sovereign, protectionist) could well reduce, or even partially negate, the effects of the current cycle of key rate cuts in certain countries. Such a phenomenon would thus limit the future effectiveness of further rate cuts. It could therefore well compromise the prospects for a rebound in activity in the short term and will need to be monitored closely in 2025.
Article written on 11/27/2024
[1] Very broadly speaking, during monetary tightening (or loosening), key interest rates tend to rise (fall) and spread throughout the economy, whether through an increase (decrease) in interbank lending rates, bank lending rates, interest rates on public debt repayment, etc.
[2] According to this logic, long-term rates are made up of short-term rates plus a term premium that varies according to the perception of each country’s specific insolvency risk over different time horizons. This term premium is based on various criteria: inflation forecasts, currency risk, liquidity risk, economic and political environments, etc.
[3] +19 bps between mid-September and end-November 2024 for the 10-year OAT, compared with a reduction in key interest rates by the European Central Bank of -110 bps between May and November 2024. The spread relative to the 10-year German Bund also widened, increasing by +10.7 bps over the same period. This topic was the subject of another Killer Chart published by BSI Economics.
