When could rate cuts begin in Canada and Europe?

Executive summary:

In recent remarks, officials from both the European Central Bank and the Bank of Canada pushed back a bit on the market's timeline for 2024 rate cuts
The Bank of Japan may not raise rates as soon as markets expect
Strong economic data and the likelihood of Fed rate cuts have helped the U.S. stock market reach new highs

On the latest edition of Market Week in Review, Director of Investment Strategies, Shailesh Kshatriya, and ESG and Active Ownership Analyst Elizabeth Jackson discussed the latest developments from recent central bank meetings. They also chatted about key drivers behind the recent strength in U.S. equity markets.

European Central Bank, Bank of Canada leave rates unchanged

Jackson and Kshatriya opened the conversation by unpacking the highlights from recent policy meetings held by the Bank of Canada (BoC) and the European Central Bank (ECB) the week of Jan. 22.

Kshatriya said that both banks left borrowing costs unchanged, with the BoC holding its benchmark rate steady at 5% while the ECB kept its overnight rate at 4%. In similar fashion, officials from both banks indicated that while they’re likely finished hiking rates, they see any discussion of rate cuts as premature, Kshatriya said.

He explained that there are two key reasons why neither the BoC nor the ECB is focusing on rate cuts yet. One reason is that inflation remains sticky in both Canada and Europe, Kshatriya said. Case-in-point: Consumer prices rose 3.4% in Canada in December on a year-over-year basis - up from 3.1% in November - while core inflation ticked up 3.4% in the eurozone.

“Inflation remains above the target range of 2% in both regions, and BoC and ECB officials would like to see this decline more sustainably toward 2%. The reality is, inflation just hasn’t cooled to that level yet,” Kshatriya stated.

The second factor likely keeping both banks from discussing rate cuts is wage growth, Kshatriya said, noting that BoC and ECB officials see wage pressures as both elevated and inconsistent with their 2% inflation targets.

He said that while markets are anticipating both banks will begin cutting rates sometime this spring, the latest remarks from ECB and BoC officials show they’re pushing back on the market’s timeline a bit. Kshatriya finished by noting that while the timing of the first round of rate cuts remains uncertain, he believes that both the ECB and the BoC will lower borrowing costs at some point this year.

When could the Bank of Japan raise rates into positive territory?

Jackson and Kshatriya shifted the conversation to the Bank of Japan (BoJ), which has maintained a negative interest rate of -0.1% since 2016. Kshatriya explained that investors have been trying to decipher when the BoJ could lift rates into positive territory, with current market pricing zeroing in on the second quarter of 2024 as a potential starting time.

However, Kshatriya believes there’s a chance the market may be getting too ahead of itself with this timeline. Why? “One reason is that Japan’s updated inflation forecast calls for inflation to hover around 2% for the next few years. 2% inflation is not all that threatening, and quite frankly, it would probably be welcomed by the BoJ, given that it’s been dealing with deflation for such a long time,” he explained.

Another reason pertains to actions by other key central banks, Kshatriya said. With the ECB, the BoC and the U.S. Federal Reserve (Fed) all likely to potentially cut rates around the middle of 2024, the BoJ might not be as willing to hike at the same time, he said. “Ultimately, I think there could be a bit of disappointment ahead for markets pertaining to the timing of the BoJ’s potential policy change,” he remarked.

Economic strength helps propel U.S. equity benchmarks to new highs

Jackson and Kshatriya wrapped up the segment by examining the key drivers behind the strong start to U.S. equity markets in 2024. Kshatriya noted that the benchmark S&P 500® Index reached another record high on Jan. 25, closing at 4,864, while the Dow Jones Industrial Average closed above 38,000 for the first time in history on Jan. 22.

One of the key factors propelling U.S. equities to new highs is strength in the nation’s economy, he said, noting that PMI (purchasing managers’ index) surveys for both the manufacturing and services sectors rose during January. In addition, U.S. fourth-quarter GDP (gross domestic product) came in better than expected, growing at a 3.3% annualised rate on the back of strong consumer spending, Kshatriya said.

“The U.S. economy had a pretty nice handoff from 2023 into 2024, and so far, some of the indicators we’re seeing for 2024 look pretty healthy, too,” he remarked. Kshatriya said the latest data generally supports the idea that the U.S. could be headed toward a soft landing.

Another factor behind the U.S. market’s strength is the Fed’s pivot to a more dovish stance, with central-bank officials pencilling in multiple rate cuts for 2024, he noted. “This has been a positive for the stock market overall as well,” Kshatriya concluded.

Watch the video Listen to the podcast

Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.