Why Europe Can Lead on Rate Cuts

Is
European
Inflation
Under
Control?

I
can’t
recall
a
period
in
time
when
the
words
of
central
bankers,
and
individual
economic
data
releases,
no
matter
how
mundane,
have
held
so
much
significance
in
the
eyes
of
investors.
On
our
valuations,
both
the
US
and
European
markets
are
fairly
valued.
That
is
despite
relatively
weak
economic
growth,
high
levels
of
government
debt,
and
a
cost-of-living
crisis
in
both
regions.

So
why
are
market
valuations
elevated
despite
all
of
these
obvious
negatives?
Essentially
investors
are
seeing
through
the
current
malaise
and
eagerly
anticipating
interest
rate
cuts
from
the
near-record
highs
we
are
experiencing
now.
How
soon
these
interest
rate
cuts
come
however,
is
heavily
dependent
on
a
number
of
factors.

So
how
is
the
economy
faring
up,
and
are
central
bankers
in
a
realistic
position
to
cut
rates
soon?

In
the
US,
inflation
is
hovering
at
just
over
3%.
A
large
climbdown
from
the
more
than
9%
levels
witnessed
not
two
years
ago,
but
still
more
than
50%
above
the
Federal
Reserve’s
targeted
level.
In
Europe,
inflation
has
fallen
harder
and
faster,

with
the
most
recent
reading
showing
inflation
at
just
2.6%.
Still
some
way
off
that
key
2%
level,
but
the
momentum
and
trajectory
of
the
fall
appears
to
be
slowly
chipping
away
at

the
European
Central
Bank’s
concerns
around
a
resurgence
in
inflation.

Europe
Won’t
See
Much
Growth
in
2024

Another
concern
of
central
banks
was
that
cutting
interest
rates
at
this
point
might
exacerbate
an
overheating
economy.
In
the
US,
GDP
currently
sits
north
of
3%,
a
more
robust
performance
than
many
economists
had
predicted
last
year.
This
contrasts
sharply
with
the
eurozone,
where
GDP
growth
is
currently
flat,
having
actually
turned
negative
in
the
third
quarter
of
2023.
For
the
most
part,
neither
situation
should
deter
central
bankers
from
cutting
rates.
In
the
US,
our
forecasts
point
to
an
encouraging,
but
modest,
2%
growth
in
2024.
While
for
Europe,
the
economy
is
unlikely
to
grow
at
all
in
2024.

Central
banks
rely
heavily
on
labour
market
indicators
to
understand
the
potential
of
the
economy
to
overheat.
When
these
markets
are
tight,
wage
growth
can
be
a
strong
driver
of
inflation.
Once
again,
the
situations
in
Europe
and
the
US
diverge
from
each
other.
Both
have
seen
a
strong
uptick
in
employment
numbers
over
the
last
three
years,
but
for
the
US
the
change
has
been
more
pronounced.
Unemployment
has
ticked
up
from
its
early
2023
lows,
but
remains
below
4%
in
the
US.
In
Europe,
where
unemployment
is
structurally
higher
than
the
US,
the
number
sits
at
historical
lows
of
6.4%.
While
neither
number
raises
any
material
flags
for
central
banks,
there
is
certainly
less
of
a
danger
of
resurgent
wage
inflation
in
Europe.

Rate
Cut
Forecasts
Can
Change
Again

Our
current
stance
is
that
the
Federal
Reserve
will
cut
rates
in
June,
with
the
most
recent
Reuters
poll
of
economists
also
predicting
the
ECB
will
cut
at
the
same
time.
But
if
we’ve
learned
anything
over
the
last
12
months
it’s
that
rate
cut
expectations
often
get
pushed
out,
and
rarely
pulled
in.

Ultimately
the
risks
to
cutting
are
much
lower
for
the
ECB
than
the
Fed,
with
Europe’s
economy
more
likely
to
deteriorate
further
than
overheat
any
time
soon.
So,
if
the
ECB
does
in
fact
cut
rates
ahead
of
the
Fed,
how
will
this
affect
European
equity
markets?

Certainly
any
large
stimulus,
in
the
form
of
rate
cuts,
is
good
news
for
the
economy,
which
should
ultimately
filter
through
to
improved
corporate
profitability.
So,
while
we
believe
that
equity
markets
in
Europe
are
fairly
valued
currently,
further
inflows
to
markets
from
enthused
investors
could
push
markets
higher.

Which
Stock
Sectors
to
Look
Out
For?

•


Financials,
which
saw
a
material
boost
over
the
period
of
high
interest
rates,
could
come
under
pressure
in
some
areas,
namely
banks
and
insurance
companies.

•
Both


consumer
sectors
have
been
beaten
up
of
late,
as
sales
growth
has
come
under
pressure
after
a
sustained
period
of
high
inflation,
with
many
consumers
struggling
to
afford
higher
costs.
Rate
cuts
will
filter
down
to
lower
mortgage
rates
and
should
slowly
alleviate
the
pressure
on
consumers
and
consumer-facing
firms.

•

Utilities,
a
sector
many
investors
shied
away
from
as
bonds
offered
equally
attractive
yields,
could
swiftly
come
back
into
fashion.
The
European
utility
sector
pays
a
dividend
north
of
4.5%
and
trades
at
a
20%
discount
to
fair
value
too.

Michael
Field
is
Morningstar’s
European
market
strategist

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