Europe’s rush for rate cuts shifts global market power away from the US

Traders stepped up bets for UK easing after the Bank of England (BOE) last week held rates at 16-year highs of 5.25% but trimmed inflation forecasts, pushing sterling down and stocks higher.

That came after Sweden cut rates for the first time since 2016, while Switzerland cut rates in March and the European Central Bank (ECB) has flagged a June cut. In contrast, the US Federal Reserve is set to keep rates high for longer.

“This is the European pivot,” said Florian Ielpo, head of macro at Switzerland’s Lombard Odier Investment Management, who is positive on European and UK stocks. 

Since 2020, the US has generated the lion’s share of global equity gains.

Paul Flood, multi-asset portfolio manager at Newton Investment Management, said he was buying UK stocks on valuation grounds and was positive on UK government bonds because there was more potential for BoE rate cuts ahead.

Doves fly

Britain’s exporter-focused FTSE 100 hit a new record high after the BoE meeting. Europe’s Stoxx 600 index rose more than 2% last week, poised for its best week since January.

Money markets are pricing in around 70 basis points (bps) of ECB rate cuts in total by year-end, 55 bps from the BOE and just 43 bps from a Fed still grappling with strong inflation.

Economists polled by Reuters expect the US economy to expand by 2.5% this year, versus 0.5% in the euro zone and 0.4% in the UK, as lavish government spending dubbed “Bidenomics” spurs investment but raises debt and the deficit.

In terms of growth momentum, investors see Europe doing better, boding well for assets in the region over the longer term.

“Europe is really accelerating, albeit from a weaker base at a time where the US economy is cooling from a stronger starting point,” said JP Morgan Asset Management global market strategist Hugh Gimber.

Investors are querying whether the US will run out of steam, other strategists said.

But in the short term, if the US can run up its debt and its deficit, then rates in the US will likely stay higher than in Europe, said Societe Generale strategist Kit Juckes.

Risky pivots 

European government bonds could outperform the US but are likely to stay volatile as the inflation path worldwide remains unpredictable, investors and analysts said.

The BOE, the ECB and other European central banks might regret sounding too dovish too soon, Lombard Odier’s Ielpo said.

In the US, the Fed sent a strong signal in December that rate cuts were coming but then turned more hawkish after financial conditions became euphoric and inflation stalled above its target.

UK gilts have lost investors 3.1%, this year, compared with 2.1% losses in the US and 1.2% in the euro zone.

BlueBay Asset Management portfolio manager Neil Mehta said the firm does not like bonds in the UK, partly because of relatively high inflation.

The yield on Britain’s rate-sensitive two-year gilt GB2YT=RR slipped 3 bps after the BoE decision to 4.28% as debt prices firmed slightly.

The BoE last diverged significantly from Fed policy in August 2016, when it cut rates by a quarter point to insulate the economy from Brexit while the Fed was on hold and preparing to raise.

The ECB was a holdout dove with rates below zero from 2014 to 2022 but has followed the Fed since.

The divergence theme would mostly play out in currency markets, Mehta added, with the dollar staying strong, in a further risk for inflation in Europe as import prices rise.

The euro EUR=EBS is down 2.6% so far this year to $1.07, Sterling is down roughly 2%.

Matthew Swannell, economist at BNP Paribas, said this was not a particular risk for UK, whose biggest trading partner is the European Union.

“So we do think the Bank of England can move before the Federal Reserve, and likewise the ECB (can too),” he said.

Reuters