In reality, the potential for a fall in short-term interest rates is limited

In late 2023, financial market participants believed that the Federal Reserve was going to cut its key interest rates (the Fed Funds rate) by 250 basis points over two years (the expected Fed Funds level at end - 2025 was 3%). They also believed that the European Central Bank was going to cut its interest rates by 250 basis points by the end of 2025; the expected repo rate level at end-2025 was 2%. These short-term interest rate expectations were completely unrealistic. If we start with expected inflation of 2.6% in the United States (this is the level of 5-year or 10-year inflation swaps) and potential growth of 2.5%, we arrive at 5.1% nominal growth, which makes it impossible to cut interest rates to 3%. And if we start with expected inflation of 2.3% in the euro zone (this is the level of 5-year or 10-year inflation swaps) and potential growth of around 1%, we arrive at 3.3% nominal growth, which makes it highly unlikely that short-term interest rates will be cut to 2%. In reality, the margin for cutting short-term interest rates is reduced if an abnormally expansionary monetary policy is rejected. In the United States, the Fed Funds rate could be cut by a maximum of 50 basis points over two years; in the euro zone, the repo rate could be cut by 100 to 125 basis points to 3.25% or 3.5%, the level of nominal growth.