Experts warn that AI could factor in ECB and Fed interest rate changes

Lesson from history as policy harkens back to tech boom of the 2000s

Life

Credit: Mabel Amber

The European Central Bank (ECB) and the US’ Federal Reserve are expected to cut interest rates within a few months, however experts are wondering what the neutral policy rate, where inflation remains stable, will be. Some strategists have warned it could be higher than expected by looking at the trend set by the basis of the tech boom in the early 2000s in the context of the rise of artificial intelligence. History could be repeating itself.

Central banks have adjusted interest rates upward over the past two years to dampen skyrocketing inflation. It is now easing in many countries, leading markets to prepare for the first interest rate cut.

According to the market, it is certain that the ECB will cut interest rates in June. Investors are basing this on the latest inflation report, which showed that consumer prices in the euro zone increased by 2.4% in March. In February, inflation was 2.6%.

In the US, the probability of a first rate cut in June is less certain. This week we will find out if US inflation is losing momentum. It stood at 3.2% in February. That was a slight increase over January’s 3.1%.

To what level should interest rates fall will involve looking at the so-called neutral interest rate. This is the policy rate where the economy is neither stimulated nor slowed down, keeping inflation stable.

Ashwin Alankar and Myron Scholes, strategists at Janus Henderson Investor, warn that those interest rates may well be higher than expected. In doing so, they shed light on the Federal Reserve. “The Fed has been explicit that a 2% inflation target and a neutral policy rate of about 2.5% are appropriate to maintain price stability and maximise employment. But we are not so sure about that.”

Scholes and Alankar think Fed chairman Jerome Powell and his team will continue to aim for 2% inflation and a neutral interest rate of 2.5%, but are willing to accept levels above those targets. They note that there is already precedent: “During the first wave of the tech boom… neutral interest rates climbed to 5%. Similarly, a Fed funds rate between 3% and 3.5% may seem restrictive, but in fact reflect an AI-based economy.”

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