Following the overnight news that Canada has become the first G7 member to cut interest rates, all eyes are now focused on the ECB and their landmark decision which is due this afternoon as we try to work out when we’ll start to see an easing of Monetary Policy. With the markets fully expecting a 0.25% rate cut from the ECB, in what would be it’s first rate cut since 2019, there will be implications for investment managers whichever way they decide to go.
Commenting on the interest rate outlook, Lindsay James, investment strategist at Quilter Investors, said: “Markets are poised for a pivotal day as the ECB is widely expected to initiate its rate cutting cycle with a first quarter point cut. The Bank of Canada has already stolen a march by reducing its lending rate by 0.25 percentage points to 4.75%, hinting at potential further cuts after inflation fell to 2.7%, a level which still exceeds the rate of inflation in both the UK and Eurozone.
“With the risk of central bank divergence seemingly dissipating, as expectations for rate cuts in 2024 in the US have been growing in recent days and economic data has suggested that inflation is being tamed as growth is beginning to slow, this may be adding to the confidence of central bankers outside of the US to make their move, with less concern about ensuing currency risks or capital flows.
“Data out in the US yesterday underlined this point, with the ISM Services PMI Report on Business highlighting contractionary employment conditions and a slowing pace of input cost inflation. On the flip side, activity in the services sector beat expectations, with economic activity growing again in May after an initial contraction in April. This reflects an acceleration in new orders, in sharp contrast to the apparent weakness reflected in the Manufacturing survey, which remains in contractionary territory.
“In encouraging signs for the UK economy, the British Chambers of Commerce updated its growth forecasts for this year to 0.8% from an earlier prediction of 0.5%, and to 1% in 2025 from 0.7%. This is likely to be mirrored by other economic forecasters in time due to the better than expected data out in Q1 when the economy emerged from recession with quarter on quarter growth of 0.6%, amidst signs of strength coming from sectors including transportation and the scientific research as well as the retail sector. While poor weather in Q2 may dampen this contributor to an extent, with retail sales volumes reportedly having fallen 2.3% in April following a fall of 0.2% in March, a more optimistic mood through the coming months, potentially buoyed by political promises, a summer of sport and most importantly the prospect of lower interest rates could see the UK economy again beat low expectations.”
Also sharing his thoughts ahead of the ECB decision later today, Dave Chappell, Senior Fund Manager, Fixed Income at Columbia Threadneedle Investments, said: “Had the ECB not telegraphed the rate cut this week so emphatically, we believe that there would have been a heated debate around whether to wait for more data following the less than supportive wage and inflation prints over the last couple of weeks. It is highly likely that Lagarde will guide markets to a hold at July, with the next adjustment either in September or October.“
Also assessing the ECB situation, according to Alberto Matellán, chief economist at MAPFRE Inversión, the data does not support a rate cut at this time as he and MAPFRE’s Ismael García Puente explain in analysis as follows:
Investors are paying keen attention to the June meeting of the European Central Bank (ECB), and at which a 25-basis point drop in interest rates is expected to be announced. The question is whether this cut is justified from a macroeconomic point of view…
Inflation doesn’t seem to be slowing down in Germany quite as it should be: prices rose by 2.4% in May – the first increase in inflation since December and two tenths higher than the April and March level.
According to Alberto Matellán, chief economist at MAPFRE Inversión, the good news is that “the market has absorbed that message,” and insists that seeing a slight upturn “isn’t too important – it would be altogether more worrying if it was much higher than expected.” In any case, this persistence of inflation, together with the improvement in growth data we’ve seen in recent quarters, means that the lowering of rates in Europe isn’t justified.
“The macro situation in Europe doesn’t justify rate cuts, certainly not a cycle of them. We have growth, weak as it is, and it’s beginning to improve. There are other nuances, such as financial stability, but looking at the macro data, this isn’t justified,” says Matellán.
Meanwhile, in the US, the inflation rate remains above that of Europe, closer to 3% than the 2% target, so lowering rates across the Atlantic wouldn’t be justified either, especially if the strength shown by the US economy in recent quarters is taken into account.
Optimism in the markets
Ismael García Puente, head of investments and fund selection at MAPFRE Gestión Patrimonial (MGP), points out that the current market scenario is what investors would have wanted at the beginning of the year in terms of equity returns, but not so much with fixed income, which has suffered the most.
Stock markets have managed double-digit gains, and despite the sharp increases in recent months (with the exception of April), Matellán reckons they still have some upside left in them. García Puente explains that the equity strategy is now positioned positively for the medium and long term, including in Asia, Japan and the U.S.A. “That’s where we want to have clients invested, in companies that are boosting productivity,” he points out.
The prospects for fixed income could also improve in the coming months. “If we look at how it’s evolved compared to the macro situation, interest rate expectations and investors’ optimism, the returns are in reasonable ranges and could rise further,” says Matellán. In fixed income, MGP doesn’t see any asset as a “clear purchase” and, for the time being, it’s beginning to extend the duration of public debt in investment grade to four or five years.
“Now is the moment of truth for central banks to see if the inflation that has pushed us toward interest rate hikes is starting to converge around the 2% target,” says García Puente.
