🔖 This week’s economic term Big Cut or Baby Cut
Table of Contents
This week’s economic terms provide the information you need to understand the global economy.
A term for the central bank’s monetary policy that is distinguished by the extent of the interest rate cut. If the interest rate is lowered significantly, it is called a big cut, and if the interest rate is lowered slightly, it is called a baby cut. A big cut usually means a 0.5%p cut, and a baby cut means a 0.25%p cut.
Since the COVID-19 pandemic, the world has been in turmoil due to soaring prices. At this time, major central banks such as the US Federal Reserve (Fed), the European Central Bank (ECB), the Bank of England (BoE), and the Bank of Korea (BOK) have struggled to control prices through monetary policy.
As a representative method, central banks of major countries have implemented policies to suppress inflation by raising base interest rates and reducing the amount of money in circulation.
⛓️ Relationship between prices and base interest rates
📈 When prices rise, things become more expensive. Inflation occurs. People’s living expenses increase and they have to spend more money to maintain their lives, so the market overheats. The central bank raises the base interest rate to prevent this economic overheating. When interest rates rise, it becomes more expensive to borrow money, so people borrow less and spend less. This reduces consumption and investment, slows down economic activity, and has the effect of suppressing inflation.
📉 When the inflation rate is low or prices are falling, the prices of goods also fall. When people see the prices of goods continuously decreasing, they think, ‘It will get cheaper later’ and do not buy goods and wait. The market will become inactive. The central bank wants people to spend more money. It lowers the base interest rate to stimulate the economy. When interest rates are low, it is cheaper to borrow money, so people will borrow more money and spend more. Since it is easier to borrow money, consumption and investment are promoted. This has the effect of activating economic activity and raising prices to an appropriate level.
After two years of efforts to stabilize prices by raising interest rates, central banks have begun to consider lowering interest rates as inflation has fallen to the target level of 2% year-on-year. This point in time when interest rate policy changes is called a “pivot.”
As interest rates are the most influential factor in the global economy, attention is focused on how much the Federal Reserve, the central bank of the United States, will lower its base interest rate.
In this regard, the terms that frequently appear in economic articles are ‘Big Cut’ and ‘Baby Cut.’ These two terms indicate how much the central bank will cut the base interest rate.
Here, ‘cut’ refers to the extent of the interest rate cut. A big cut usually means a 0.5%p cut, and is used for strong economic stimulus when the economy is in a serious recession. On the other hand, a baby cut means a 0.25%p cut, and is chosen when the economic situation is somewhat uncertain but a drastic adjustment is not necessary.
For reference, the term ‘step’ was used instead of ‘cut’ during the interest rate hike two years ago. A step is the opposite of a cut, referring to the extent to which the interest rate is raised. Usually, a 0.25%p increase is typical, and this is called a ‘baby step’. A 0.5%p increase, which is a bit larger, is called a ‘big step’.
Now that I think about it, baby cuts and baby steps, big cuts and big steps have similar structures. If we organize them into a single table, it looks like this:
‘Big Cut’ or ‘Baby Cut’? The Direction of the Won/Dollar in September (Newsis 2024.9.2)
As the US September interest rate becomes a fait accompli, attention is focused on whether it will be a ‘big cut (0.5% point cut)’ or a ‘baby cut (0.25% point cut)’. As Federal Reserve Chairman Jerome Powell hinted in his speech that employment indicators will be the main basis for interest rate decisions, there is a view that the employment report to be released this week will be a turning point for the exchange rate.
If a hard landing in the US economy is confirmed, the possibility of a ‘big cut’ increases and the dollar value may fall significantly. However, some believe that the US employment market is slowing down, but it is not at a level to be concerned about, and thus the possibility of a 0.5% point cut is low. As the market increasingly expects employment data to be optimistic, the outlook that the expected exchange rate in September will move around the current level of 1,330 won is gaining strength.
As of 10:30 a.m. on the Seoul Foreign Exchange Market on the 2nd, the won-dollar exchange rate is trading at 1,337.0 won, up 1.0 won from the closing price (1,336.0 won) at 3:30 p.m. on the previous trading day. (Omitted)
The U.S. Federal Reserve has finally signaled that it is ready to cut interest rates. With inflation getting closer to its 2% target and employment slowing, the time has come to cut rates.
In a situation where a cut in the base rate is certain, the key question is how ‘strongly’ the rate will be lowered. Currently, two scenarios are being presented.
The first is the ‘Big Cut’, which is a method of reducing the rate by 0.5%p at once. The Big Cut also gained strength when the US non-farm payrolls in August announced on the 6th increased by 142,000 compared to the previous month, falling short of Wall Street’s expectations (164,000).
This would have a significant economic stimulus effect, but it would also likely lead to a significant decline in the value of the dollar. A weaker dollar would be beneficial for U.S. exporters, but it would also put pressure on prices as import prices rise.
The second scenario is a ‘baby cut’. This is a method of lowering the rate by only 0.25%p. Since major central banks usually lower interest rates by 0.25%p, the market predicts that the baby cut will have a higher probability.
In this case, the economic stimulus effect will be slightly less, but the dollar is unlikely to weaken sharply. If the Fed chooses this method, it will be a choice to continue to carefully adjust interest rates while minimizing market volatility.
In conclusion, the U.S. economy’s inflation and employment situation is foreshadowing a rate cut, and everyone is paying attention to how strongly the rate will be lowered. The final decision is expected to be made at the Federal Open Market Committee (FOMC) meeting on September 17-18. Depending on the results announced at that time, it is expected to have a significant impact on the value of the dollar and the won-dollar exchange rate. It can be seen as a time when we should pay more attention to future market reactions and economic indicators.
The base interest rate announcement is scheduled for 2:00 PM on the 18th, and Federal Reserve Chairman Jerome Powell’s remarks are scheduled for 2:30 PM. (Based on Korean time, 3:00 AM and 3:30 AM on the 19th, the day after the holiday) From the perspective of domestic investors, they will have to accept the results of the U.S. monetary policy without the opportunity to adjust their positions due to the three-day Chuseok holiday right before the FOMC.
Accordingly, experts recommend investing in stocks with relatively low volatility, such as increasing the proportion of cash and reducing the proportion of stocks. In particular, as the won/dollar exchange rate falls, foreigners who want to realize short-term exchange rate profits are flowing into the domestic stock market, which could lower the index, so there are opinions that it is necessary to respond by focusing on stocks with low foreign ownership.
The market going forward is likely to see one or two major volatility events as the direction of the economy and the extent of the interest rate cut to be decided in September are discussed. A technical rebound may also occur, and it can also be noted that short-term trading movements may be seen in industries such as semiconductors, IT, automobiles, and machinery.
- Base rate: The interest rate that serves as a reference point that affects other interest rates. It is the central bank’s policy rate, and is used as an important indicator to determine the level of interest rates throughout the economy. If the economy overheats and prices rise too much, the base rate is raised to collect money in the market, and if the economy is in a recession and money is not circulating in the market, the base rate is lowered to supply liquidity to the market, thereby maintaining the economy in a stable manner.
- Quantitative easing: When the effect of stimulating the economy through interest rate cuts is limited, the central bank directly supplies liquidity to the market by purchasing large amounts of government bonds or financial assets. The central bank hopes to relieve the credit crunch and promote economic growth through quantitative easing.
- Price Stability Targeting System: A system in which the central bank sets in advance the inflation rate target to be achieved in the medium term and maintains it. Currently, the inflation target of the U.S. Federal Reserve (Fed) and the Bank of Korea is usually 2%. When this target is approached, interest rate cuts or increases are considered.
References
Edit Geum Hye-won Graphic Jo Su-hee Lee Dong-geon
Understanding “Big Cut” and “Baby Cut” in Monetary Policy
In the world of economics, central banks play a crucial role in stabilizing prices and promoting economic growth through monetary policy. One of the key tools they use is setting interest rates, which can have a significant impact on the economy. Recently, two terms have become increasingly popular in economic articles: “Big Cut” and “Baby Cut.” But what do they mean, and how do they affect the economy?
**What are “Big Cut” and “Baby Cut”?
