Rate cuts ? Yes … but when ?

By Alexandre Hezez, Group Strategist

Several members of the European Central Bank (ECB), known for their hawkish stance (favoring a restrictive monetary policy), have publicly expressed their unanimous opinion that reducing key interest rates is premature, contrary to the expectations of financial investors.

Graph: 5-year rates

This stance has stimulated the rise in European sovereign rates. Jens Weidmann, President of the Bundesbank, emphasized yesterday the importance of not rushing into monetary easing, advocating for a strategy responsive to current economic data.

Meanwhile, Robert Holzmann, Governor of the Austrian National Bank, warned of geopolitical risks, particularly in the energy sector, which could maintain upward pressure on prices. He even mentioned the possibility that no reduction in key interest rates might be considered this year.

These statements echo those of Philip Lane, Chief Economist of the ECB, and Christine Lagarde, President of the ECB, last week. The European Central Bank cannot yet declare victory in its fight against inflation, but its next move on its key interest rate will probably be a decrease, which could occur during the course of the year, said François Villeroy de Galhau, Governor of the Bank of France, at Davos. ‘Unless there is a major surprise – I am thinking of the Middle East – our next action will be a decrease, probably this year.’ This highlights the geopolitical aspect and the potential shock to supply chains that could result.

Graph: Inflation rate

The market stress currently comes from the area where freight rates have literally exploded in a few days. The objective of the military action against the Houthis is to allow unarmed commercial ships to navigate the Red Sea with affordable ‘war insurance’ rates. When delivery times are disrupted, the parts necessary for the completion of your product do not arrive at the right time, and a chain reaction on overall prices can occur.

The inflationary pressure on goods is very real. They all ultimately reaffirmed the need for clear confirmation of disinflation before considering rate cuts, despite a notable slowdown in European growth at the end of the year, a development expected and necessary for the ECB to achieve its 2% inflation target.

These elements suggest that the discussions during the next ECB monetary policy meeting (press conference scheduled for Thursday, January 25) may not focus on a schedule for cutting key interest rates. This prospect could disappoint financial investors who are advocating for aggressive rate cuts starting in April and six consecutive decreases…

Graph: ECB rates on futures markets

We anticipate that the ECB will maintain its key interest rates at their current level at least until June 2024, before considering very gradual decreases. Nothing will happen until the Fed acts.

We believe that on the American side, there is more room for a decrease earlier in the year. This seems justified as European growth is expected to experience a more positive dynamic in the first half of the year, thanks to an increase in real wages and a recovery in demand, which could slow down the disinflation process.

Barring any major geopolitical shocks, the euro should continue to benefit from this environment. Equity markets are likely to experience greater volatility depending on the figures published. For the time being, we remain positive on the equity markets, but are keeping a close eye on inflation dynamics, which, beyond the rhetoric of central banks, remains the essential catalyst. In our view, rates fell too far at the end of the year, and we remain cautious on sovereign rates, which should react to these new conditions.

Richelieu Gestion | Flash Marchés – January 2024

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