Soft Landing in Sight—Will Central Banks Sit Tight?

Key Takeaways

• ECB sticks to 2%
• Trade deals agreed ahead of August 1 deadline
• Fed and BoC rates unchanged, but for different reasons

In the latest edition of Market Week in Review, Senior Investment Strategist and Head of Canadian Strategy, BeiChen Lin, unpacks the European Central Bank’s (ECB) latest policy decision, provides an update on U.S. trade negotiations ahead of the August 1 deadline, and previews next week’s interest rate decisions from the Federal Reserve and Bank of Canada (BoC).

At this week’s meeting, the ECB left its key policy rate unchanged at 2%. Following a 25-basis-point rate cut in the prior month, Lin notes that the most recent decision reflects a more neutral monetary policy stance, “We now think interest rates are at a level that neither helps nor hurts economic activity.”

He adds that while further cuts remain on the table, the threshold for action is now higher and would likely require a more pronounced economic slowdown in the region to justify another rate cut.

Turning to the U.S., Lin highlights trade deals reached with Japan and the Philippines ahead of the administration’s August 1 deadline.

He explains that the terms of the deals represent a bit of a setback, “The rate for Japan was 15% and the Philippines was closer to 20%. Both are higher than the tariff rate faced during the 90 day pause on tariffs.”

Lin cautions that while these agreements help reduce some near-term uncertainty, broader policy and macroeconomic risks remain elevated, with their eventual impact likely to shape the overall U.S. economic outlook.

“If tariff rates continue to be relatively measured, then the U.S. economy will most likely be able to achieve a soft-landing outcome. However, we continue to believe that the risk of a potential economic slowdown is still somewhat above average.”

With just days remaining until the trade deadline, Lin adds that he sees a strong likelihood of an extension to allow additional time for negotiations and further deals to be finalized.

Looking ahead to next week’s central bank meetings, Lin expects both the Federal Reserve and the BoC to leave rates unchanged, but for different reasons.

Lin explains that steady labor markets, solid consumer spending, and resilient quarterly earnings all suggest the U.S. economy remains robust, leaving the Federal Reserve with little urgency to ease monetary policy.

However, he emphasizes that the situation is different for the BoC, which is contending with weaker labor markets, an unemployment rate two percentage points above its 2023 low, and recent setbacks in its efforts to bring down inflation.

He cautions, “The longer rates remain on pause, the higher the risk that the BoC will have to have to make an outsized rate cut at some point in the future, to stabilize the economy“.

Lin concludes his update with a broader message that amid the current monetary policy outlook, both U.S. and Canadian bonds continue to play an important role in portfolio diversification.