ECB cuts

• Emerging markets and Asian equities gained +2.4% and 2.9% respectively in sterling terms, while European and US equites gained +1.2 and 1.3% on the same basis
• Bonds broadly gained in local currency terms, with gilts up +0.6%

• Equities in the UK and Japan, as both markets declined -0.2% in sterling terms
• Oil – Brent crude declined -2.5% in US dollar terms

Central bank activity remains an area of key focus for markets. Market participants still expect interest rate cuts across the main developed market central banks, with the exception of Japan, where the Bank of Japan (BoJ) is just beginning to tighten monetary policy.

Last week, the European Central Bank (ECB) made its first move, following the Bank of Canada in cutting rates.

As expected, the ECB’s Governing Council opted to cut policy rates at the June meeting. The Council voted for a 25bps cut, taking the marginal lending rate to 4.5%, the refinancing rate to 4.25% and the deposit rate to 3.75%.

While the Council’s statement did acknowledge progress made on inflation, the assessment was moderate. Council members judged that “it is now appropriate to moderate the degree of monetary policy restriction after nine months of holding rates steady.” However, it was also noted that "despite the progress over recent quarters, domestic price pressures remain strong as wage growth is elevated, and inflation is likely to stay above target well into next year." The statement acknowledged that policy is still restrictive, but the Council vowed to “keep policy rates sufficiently restrictive for as long as necessary” to achieve price stability, and reaffirmed that decisions will be “data-dependent”.

In addition to this moderate guidance, the forecasts accompanying the monetary policy decision push out the date at which inflation falls to the 2% target, with inflation forecasts increased in 2024 and 2025. All in all this reiterates the message that the ECB is not on the brink of an aggressive rate cutting cycle.

While the cut was widely expected, the decision follows a stronger inflation print in May. If data continues to be more resilient than expected, further cuts may not be forthcoming for some months. At the same time, global rates markets have pushed out the timing of cuts across Europe and the UK, likely a result of a repricing of expectations in the US.

While US data has generally been softer of late, Friday’s labour market report painted a confusing picture, with the data sending conflicting messages.

US labour market data has been hard to interpret year to date, with warmer weather giving construction activity a boost in March, leading to a +310,000 surge in payrolls, which fell back sharply in April to a +165,000 rise. May’s report showed payrolls bouncing back, rising by +272,000, across a broad base. Wage growth also accelerated, rising to +0.4% month-on-month, from +0.2% in April.

However, the household survey did not show such a strengthening. Indeed, households reported employment declining by -408,000 in May, after a rise of only +25,000 in April. This meant that, despite the labour participation rate moving down modestly, from 62.66% to 62.53%, the unemployment rate rose to 4% from 3.9%.

What explains the sizable gap between these two surveys? One answer could be immigration, with these workers being captured in payroll data but not in household survey data. Some economists expect immigration to continue to increase the supply of workers at the same time as demand is cooling, causing the labour market to ease further.

Elections are taking place in more than 50 countries this year, with more than two billion voters involved. Already, the outcome of these elections is having a market impact.

In India, after a seven-week election, Narenda Modi was elected as prime minister for a third consecutive term. However, his party, the BJP, did not win an outright majority after being in control of parliament for 10 years. This unexpected outcome saw Indian equities dip, after a long bull market for the asset class, reflecting unforeseen policy uncertainty. A coalition government is expected to slow the pace of reform, but not halt it.

In Mexico, the Morena party won an unexpected landslide in elections. The party and allies gained a super majority, two thirds of seats, in Congress, and a majority in the Senate. This has caused some nervousness in markets, as the outgoing Morena premier, Andres Manuel Lopez Obrador, may act to remove some of the checks and balances on government powers before leaving office. Obrador proposed a range of constitutional changes in February, which would reshape the judiciary, pare back the powers of regulatory agencies and expand (costly) social benefits. This has caused the peso to fall sharply.

Of the votes ahead, the US Presidential Election in November is likely to be the most critical and we expect volatility to increase as attention increases moving towards the vote.

 

 

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