Inflation moderates in Europe. When could rate cuts begin?

Executive summary:

  • Eurozone inflation declined to a rate of 2.8% in January
  • The U.S. Federal Reserve, the European Central Bank and the Bank of England could all lower borrowing costs by the middle of this year
  • Resilience has emerged as the key theme from Q4 earnings season

On the latest edition of Market Week in Review, Senior Portfolio Manager Olga Bezrokov and ESG and Active Ownership Analyst Zoe Warganz unpacked the latest economic data from key regions around the globe. They also discussed the impact of this data on monetary policy among global central banks, and provided an update on U.S. fourth-quarter earnings season.

Pricing pressures ease in the eurozone

Warganz and Bezrokov started the segment by assessing recent economic data readings from the eurozone, which Bezrokov said were a mixed bag. On the positive side, the composite PMI (purchasing managers’ index) for the eurozone surprised to the upside with a reading of 48.5, she said—besting January’s reading of 47.9. The services-sector PMI fared even better, rising out of contractionary territory for the first time in seven months with a reading of 50.0, Bezrokov noted. Readings of 50 and above indicate expansionary conditions, while readings below 50 indicate contractionary conditions, she explained.

Inflation in the eurozone also surprised to the downside, Bezrokov noted, with annual inflation falling to a rate of 2.8% in January. “The latest data shows that pricing pressures are definitely moderating in Europe,” Bezrokov remarked. She added that while consumer confidence remains negative in the region, it did rise in February, coming in slightly better than expectations.

On the more negative side, Bezrokov said that Germany’s composite PMI slipped to a reading of 46.1 during February, with its manufacturing PMI falling to 42.3. “The manufacturing reading came in under expectations and was Germany’s lowest in four months,” she stated, noting that the manufacturing sector will be a key watchpoint for the country going forward.

Moving over to North America, Bezrokov said that inflation in Canada cooled more than anticipated, falling to a rate of 2.9% in January on an annual basis. Meanwhile, in the U.S., weekly initial jobless claims dipped to their lowest level in a month—another indication of the relatively painless rebalancing of the country’s labour market, Bezrokov noted. In an additional positive signal, U.S. manufacturing reaccelerated during February, with the S&P Global PMI for the month rising to 51.5, she said.

Despite the recent robust data readings from the U.S., Bezrokov said there are signs that the U.S. economy is starting to slow down. “Overall, it’s still expanding, but at a slower pace. This is particularly apparent in the U.S. services-sector PMI and the latest survey from the Chicago Fed,” she noted. Bezrokov stressed that the slowdown is the intended effect of the U.S. Federal Reserve (Fed)’s recent rate-hiking campaign, which has brought the federal funds rate to a 22-year high.

Zooming out for a broader global view on inflation, she said that overall, pricing pressures are moderating in developed economies around the world. “This positive development gives central banks more room to make adjustments to monetary policy if they need to step in and support economic growth rather than slow it down,” Bezrokov stated.

When could rate cuts begin in Europe? What about in the U.S.?

Focusing in on monetary policy, Bezrokov said that the future path of interest rates in the U.S., the UK and the eurozone may start to diverge a little in the coming months due to differences in inflation and growth rates.

For instance, the U.S. Federal Reserve (Fed) could start lowering borrowing costs mid-year if inflation continues to move closer to the central bank’s target range of 2%, she said. Bezrokov noted that minutes from the Fed’s last policy meeting, released the week of Feb. 19, showed that most officials remain concerned about the risks of cutting rates too soon, as doing so could potentially cause inflation to reaccelerate. “Based on this, I don’t expect the Fed to lower rates in March, but I think a rate cut in May or June is still possible,” she stated.

The moderation in eurozone inflation also means that the European Central Bank (ECB) could begin lowering its benchmark policy rate around roughly the same time, Bezrokov remarked, adding that traders are anticipating that the Swiss National Bank could begin cutting rates as soon as March.

The UK, meanwhile, is in a trickier spot, with the country now in a technical recession, she noted. “This suggests that the Bank of England (BoE) will likely shift to a more accommodating monetary policy stance later this year, especially with inflation continuing to moderate,” Bezrokov said, stressing that the timing of the first BoE rate cut remains uncertain.

Q4 earnings season report card

Warganz and Bezrokov wrapped up the segment with a look at key themes from U.S. fourth-quarter earnings season, which is nearly complete, with over 90% of S&P 500 companies having reported results.

Bezrokov said the main theme of the season is that overall earnings have been very resilient, with earnings growth north of 10% from the companies that have reported. In addition, approximately 70% of companies have beat earnings expectations for the fourth quarter of 2023, she remarked.

However, there is a pretty significant disparity among sectors, Bezrokov said. “Tech companies are delivering over 40% of the earnings growth, while on the other end of the spectrum, companies in the energy and materials sectors have seen an earnings contraction of roughly 20%,” she concluded.

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