Central Banks and Rate Cuts in a post-pandemic world

Aarush Bathula

At the time of writing, the Bank of England is a day away from announcing its decision on whether or not to cut interest rates, which currently stand at 4.75%. Just a week prior, the Federal Reserve decided to hold rates steady, much to the dismay of bullish investors.  2025 is a pivotal year for global monetary policy, as lingering inflation concerns, uneven recoveries from the pandemic and shifting trade dynamics impact central banks' decision-making. This article seeks to analyse the context, indicators, challenges and forward-looking decisions made or to be made by the U.S. Federal Reserve (the Fed), Bank of England (BoE), European Central Bank (ECB), Bank of Japan (BoJ), and the Bank of Canada (BoC), with a primary focus on the first two.

Federal Reserve

Since the Federal Reserve heavily influences global financial conditions, it makes sense to first analyse its current situation. For a brief overview, the Fed operates on a dual mandate of maintaining stable prices (i.e., controlling inflation) and minimising unemployment. Currently, the Fed rate stands at 4.5%, the lowest since early 2023.

The attached graph shows that the rates have been on a downward trend since mid-2024. The question, then, forms: Is the Fed cutting rates too slowly? Most of the answers surrounding this question stem from a couple of primary concerns that seem to keep policymakers wary of overly liberal rate cuts. For starters, the Fed's attempt to rein in inflation has been rendered particularly challenging since inflation remains sticky. Although down from the 2022 peak of 9%, inflation has remained well beyond the Fed target of 2% since March 2024. Further, the U.S. economy has looked increasingly strong in the last few months of the Biden presidency, with solid labour market figures. Unemployment stood at 4.1%, with greater-than-expected payroll employment gain (+256,000) while labour force participation remained unchanged at 62.5%. These figures show that concerns over weakening in the job market have eased, allowing the Fed to be more measured and less urgent in cutting rates.

However, there are now an increasing number of exogenous shocks that could complicate the Fed's model for making interest rate decisions. The vast majority of these shocks come from the inflationary policies that newly -inaugurated President Trump has promised and begun acting upon, namely mass deportations and levying tariffs against other major trade partners such as Canada, Mexico, Panama and China. With the eroding dominance of the U.S. dollar and further threats against global economies should they decide to move away from the U.S. dollar for trade purposes, the Fed looks rather cautious in its signalling of potential rate cuts later in 2025. While many economists seem to be predicting three rate cuts in the entire year, market pricing seems even harsher, with only two rate cuts priced in by Wall Street traders.

Bank of England

The Bank of England, too, operates on mandates similar to those of the Federal Reserve, with the goals of maintaining inflation levels and maximising employment.

Similarly, let us contextualise the state of the British economy in early 2025 to try and understand the motivations and routes forward for the Bank of England in its monetary policy decisions in the coming months. While looking at fundamental figures, CPI for December 2024 has come down to 2.5%, hinting that the era of high inflation might have ended. While this is closer to the BoE's 2% target inflation rate, it still hovers above it. Economic growth has stagnated, with growth of just 0.1% following two months of contraction in September and October. The labour market has been cooling, with employment rates at 74.8% and the largest contraction in job vacancies since August 2020.

 [rm1] [rm2] Markets seem to have priced in rate cuts at a certainty of 90-92%. Given these preconditions, a rate cut appears imminent; however, there remain hiccups on the path to a return to the equilibrium rates, which are currently pegged at 2-3%. One of these roadblocks is the high levels of service inflation, still standing at 4.4% as of December 2024. The Monetary Policy Committee (MPC), in charge of deciding the bank rate, is divided as members struggle to arrive at a unanimous consensus. That said, Andrew Bailey, the Governor of the BoE, has stated that the Bank is currently favouring a gradual approach. Nevertheless, exogenous shocks can continue to dictate decisions without a clear long-run path.

European Central Bank

The ECB's Governing Council consists of six Executive Board members and the governors of all 20 national central banks in the eurozone. This body is larger and more diverse than the decision-making bodies of the BoE or Fed. As such, decisions made by the ECB tend to be of higher complexity. While traditionally, the ECB looked for unanimous votes to arrive at decisions, majority-centric decisions have become more prevalent in recent years, given the varied economic circumstances.

As for the statistics, inflation is hovering around slightly above the 2% target the ECB has set out for it, and economic growth remained unchanged for the quarter. The recent rate cut in January is was the fourth consecutive cut, bringing the main refinancing rate to 2.90% (usually considered the benchmark rate). Weaker-than-expected growth is cited as the primary reason for the relatively aggressive rate-cut strategy being pursued by the ECB, which almost paradoxically does not have to consider nearly as many exogenous shocks as the Fed or the BoE. Goldman Sachs' 2025 forecast report for the EU predicts nonnegative growth even after accounting for the impact of Trump's tariffs, highlighted by the strong predicted growth in Southern economies such as Spain, which is forecasted to grow 2% throughout the year against Germany or France which are predicted to experience contractions of 0.3% to 0.7%.

Bank of Japan

As a break from the similar situations faced by the Fed, BoE and ECB, this article also looks at the challenges and circumstances surrounding the Bank of Japan's year ahead. The Bank of Japan (BoJ) is on a significantly different path from Western central banks due to Japan's long-standing issues with deflation and ultra-low interest rates. The BoJ raised its key short-term interest rate by 25 basis points to 0.5% in January 2025, marking the third rate hike since ending negative interest rates in March 2024. After struggling with deflation for 25 years, Japan finally achieved inflation after decades of ultra-loose monetary policy to achieve its 2% inflation target, in sharp contrast to the Western economies mentioned above. Still, the 0.5% interest rate is extremely low compared to other countries. However, public pressure is mounting on the BoJ as the Japanese populace finds increasing prices deeply unpopular. This creates a glaring problem in policy communication and managing future price expectations of consumers, as stimulating growth becomes challenging in an almost cyclical manner.

Despite ending the yield curve control (YCC) program in March last year, bond purchases continued in 2024. Wages finally began to grow earlier in 2024, and the BoJ is confident that it will be able to reach its 2% inflation target by 2026. Given these circumstances, it should be no surprise that the BoJ continues its current trajectory throughout 2025 and 2026. However, Itit should be noted that despite the shift, the BoJ emphasised that "accommodative financial conditions will be maintained for the time being," suggesting a gradual approach to tightening. To achieve sustainable inflation levels, the BoJ has to employ methods to incentivise wage growth, which could drive consumer demand upwards, even higher than the 6.2% year-on-year growth in bonus payments.

Bank of Canada

Lastly, this article looks at the Bank of Canada, which is in a particularly tough spot as it grapples with the possibility of a trade war with its closest ally and an upcoming Federal election in 2025. Contextually, much of the mandate the BoC operates within is similar to the other central banks in discussion. The confounders, however, stem from the current housing and immigration crises and the political uncertainty surrounding the Trump administration.

Annual inflation in December 2024 stood at 1.8% in terms of CPI, with core inflation of 2.5%. The policy rate, having just been slashed in January 2025, is 3%. Projections for GDP growth over 2025 are mostly pegged in the 1.5% to 1.8% range. However, these figures do not tell the whole picture as much uncertainty presents itself externally from Canada's geopolitical concerns - the looming threat of a trade war.

The situation is rapidly evolving at the time of writing, so note that circumstances could have changed since the publication of this article. RBC suggests that the shock from the tariffs could be the largest trade shock Canada may experience in nearly 100 years. While the Trump administration announced a swathe of tariffs (with expected retaliatory tariffs from Canada), much of these were delayed. At the same time, the two nations scrambled to arrive on terms to avoid a potential trade war that could gut the economic prospects for both nations. Barring this, economic conditions are not the brightest for Canada. Canadian households now owe more than the country's entire GDP, with household debt at 107% of GDP, gripping the country's consumption patterns. The BoC has much to consider when coupled with the expected growth in house prices.   As for future trajectory, the Bank of Canada is expected to cut interest rates in 2025, with variable mortgage rates projected to decrease. However, the imposition of tariffs could serve as an inflationary roadblock. Should such measures be taken, the likelihood of rates being held at the current 3% or even hiked should not be discounted.

Comparative Analysis

Across major economies, central banks are juggling inflation control and growth concerns. The Federal Reserve and Bank of England remain cautious due to inflation above their 2% targets, while the European Central Bank cuts rates more aggressively to counter weak growth. Japan, emerging from decades of deflation, keeps interest rates comparatively low, and Canada contends with trade uncertainties and high household debt. Shifting geopolitical factors—such as U.S. tariff policies and Brexit—add complexity, making transparent policy communication vital. Each central bank's 2025 approach depends on inflation trends, labour market conditions, and external shocks. Ultimately, they must maintain economic momentum without sparking renewed inflation or destabilising financial markets.