The ECB cut the deposit facility rate by 25 basis points and the main refinancing and marginal lending rates by 60 basis points. This is the second time this year that the ECB has cut interest rates, following a landmark rate cut in June.
The ECB said that the latest inflation data was largely in line with expectations, and its latest forecast confirmed the previous inflation outlook. The central bank expects headline inflation to average 2.5% in 2024, 2.2% in 2025 and 1.9% in 2026, as projected in June.
It expects inflation to rise again in the second half of the year, in part because the previous sharp drop in energy prices will be removed from the annual inflation rate. By then, inflation should come down to our target level in the second half of next year.
For core inflation, the forecast for 2024 and 2025 has been revised slightly upwards as services inflation comes in higher than expected. At the same time, staff continue to expect core inflation to fall rapidly, from 2.9% this year to 2.3% in 2025 and 2.0% in 2026.
While inflation in the eurozone remains high, labor cost pressures are easing, with profits cushioning the impact of rising wages on inflation to some extent. Financing conditions remain constrained and economic activity remains subdued, reflecting weaker private consumption and investment.
On September 12, European stock markets rose across the board. Germany DAX rose 1.3%, France CAC 40 rose 1.0% and Eurozone STOXX50 rose 1.3%.
Source: Wind
Source: Wind
Policy Interpretation //
Some of the main drivers behind the ECB's rate cuts include sluggish growth across the eurozone and cooling inflation, which fell back to the central bank's 2% target in August. According to recent data from the European Union's statistical agency, the total GDP of the 20 member states of the eurozone increased by only 0.2% in the second quarter compared to the first quarter.
This marks a slowdown in the region's economic growth from the first quarter and much weaker than the performance of the United States and United Kingdom economies over the same period. The United States economy grew at an annualized rate of 3 percent, while the eurozone grew by just 0.8 percent. The data also showed a sharp drop in investment in the eurozone in the second quarter and a decline in consumer spending, both signs that high interest rates are cooling demand. Economic growth is mainly driven by exports and government spending.
Recently released surveys and data showed that the eurozone's economy continued to weaken in the third quarter, and Germany, the eurozone's largest economy, is increasingly at risk of slipping into recession after a three-month contraction through June. Eurostat lowered its growth forecast, in part because of a slowdown in France, the eurozone's second-largest member.
Some policymakers want to move slowly, saying that the eurozone economy is not in dire need of support and that inflation can be brought under control without a decline in output or employment, rather than a so-called hard landing.
In a recent speech, ECB Executive Board member Isabel Schnabel said: "Despite the increased risks to economic growth, the likelihood of a soft landing is still greater than that of a recession."
An economist at S&P Global Ratings said the ECB would remain vigilant over a range of risks surrounding the outlook for economic growth, including shipping costs, energy policy and international trade. Sylvain Broyer, chief economist for EMEA at the agency, said: "There are many risks to Europe's outlook."
"The ECB is watching the situation in the labor market, because the labor market is still tight at the moment, so services inflation accelerated again in the summer, because labor costs did not ease as quickly as many expected," Broyer said.
"The ECB's focus on the labour market is really a balancing act, on the one hand, the inflation risks associated with a tight labour market, and on the other hand, if labour costs become an issue for employers, economic growth could reverse and then slow sharply," he added.
Strategists at Mizuho International expect the ECB to cut the deposit rate to 3.5% from 3.75% after a 25 basis point rate cut on Thursday, with two more rate cuts before the end of the year. Evelyn Gomez-Lechetti, an interest rate strategist at the agency, said the market could see a 50 basis point or 75 basis point rate cut by the end of 2024.
Global Interest Rate Cut Cycle //
Just days after the ECB meeting, the Fed appears poised to start its own cycle of interest rate cuts. Strategists say that the monetary structure that underpins the global economy will begin to shift in phase, which could spur the market to further upside.
Whether the world's major central banks will jointly enter the interest rate cut cycle in the coming period has aroused widespread concern in the market. John · Bilton, global head of multi-asset strategy at JPMorgan Asset Management, said we are entering a longer cycle of rate cuts. The European Central Bank has already cut rates by 25 basis points, and the Fed is expected to follow its lead next week, with the Bank of United Kingdom likely to join the bandwagon. In this context, the global financial market will usher in a new inflection point.
The start of the interest rate cut cycle will undoubtedly have a direct impact on global capital markets. Bilton noted that while rate cuts are often linked to recessions, the current wave of rate cuts is not entirely due to economic imbalances, but rather to moderate inflation and a weak labor market. Central banks are trying to inject liquidity into the market by easing monetary policy to avoid further economic slowdowns.
Such a move could boost the market in the near term, especially for the more affected tech stocks and highly indebted companies. However, market participants' reactions to central bank actions are likely to be divided, with some investors likely to believe that rate cuts are too late, while others believe that economic fundamentals remain resilient and markets will receive further support.
The S&P 500 returned a median of 10.8% in the year and 9.1% in six months after the Fed began cutting rates. During the three easing cycles of 1981, 2001 and 2007, one-year equity returns were double-digit losses. However, despite the United States recession, there were four easing cycles with double-digit one-year returns: in 1974, 1980, 1989 and 2019.
A rate cut usually leads to a short-term market upturn. However, the current global economic environment is more complex. While central banks are trying to avoid a recession by cutting interest rates. Bilton's argument is that some Western central banks may have acted too late, putting the economy at risk of entering a recession.
However, he also pointed out that there are no significant structural imbalances in the global economy, and the rate cut is expected to boost investor sentiment and push the market up further. This optimism depends heavily on the resilience of the global economy and the policy coordination of governments and central banks.
In many past cycles of global interest rate cuts, it has tended to be positive for equities, as lower borrowing costs have led to increased corporate investments, increased share buybacks, and a greater preference for investors to hold risky assets. The current market focus is mainly on technology stocks and other high-growth sectors. The start of the rate-cutting cycle could further fuel the market rally, especially after the sharp fall in early August, which is already beginning to show signs of a market rally.
However, it is worth noting that going back to the fundamentals, high-growth or some technology companies usually outperform in rate-cutting cycles, as the lower cost of capital has raised their earnings expectations. However, uncertainty about the global economic outlook and high valuation pressures in technology stocks remain hidden dangers that cannot be ignored.
In FX, the performance of the US dollar is usually suppressed during rate-cutting cycles, as lower interest rates undermine the dollar's attractiveness as a high-yielding currency. However, the current global economic environment has created more complexity for the US dollar.
The interest rate cuts of advanced economies such as the European Central Bank and the Bank of United Kingdom mean that interest rate differentials between major developed countries have narrowed, which may weaken the strength of currencies such as the euro and the pound in the short term, and instead support the dollar. Therefore, for market observers, comparing the policy strength and outlook of major central banks will have a direct impact on the foreign exchange market.
The global bond market will also tend to be one of the biggest beneficiaries in the cycle of interest rate cuts. With the world's major central banks cutting interest rates one after another, bond yields have generally fallen into a trend. In particular, United States Treasury yields are expected to continue to decline after the Fed's policy direction is clear. However, the decline in bond yields is not just due to the rate cut itself, but the uncertainty of the global economic outlook that has driven safe-haven flows into the bond market.
As the first choice of global safe-haven assets, bonds will attract more global funds in times of uncertainty. But here's the interesting thing: Historically, the yield on 10-year United States Treasuries has fallen most of the three and six months since the Fed cut rates for the first time. It may seem strange that yields have moved higher a year after the first rate cut, but the market should need to take into account that recessions in the United States typically last less than a year, and that higher interest rates were needed in the '70s and early '80s to fight inflation.
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