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THE Bank of England (BOE) has sent a new signal that borrowing costs will fall earlier and further across Europe than in the United States, setting markets up for major shifts as investors play a monetary policy divide opening up across the Atlantic.
Investors see European stocks and debt leading global markets this year as rate cuts boost spending, softer inflation burnishes bonds and weaker currencies lift exports.
Traders stepped up bets for the United Kingdom easing after the BOE on Thursday (May 9) held rates at 16-year highs of 5.25 per cent but trimmed inflation forecasts, pushing sterling down and stocks higher.
That came after Sweden cut rates for the first time since 2016, while Switzerland cut rates in March and the European Central Bank (ECB) has flagged a June cut. In contrast, the US Federal Reserve is set to keep rates high for longer.
“This is the European pivot,” said Florian Ielpo, head of macro at Switzerland’s Lombard Odier Investment Management, who is positive on European and UK stocks. Since 2020, the US has generated the lion’s share of global equity gains.
Paul Flood, multi-asset portfolio manager at Newton Investment Management, said he was buying UK stocks on valuation grounds and was positive on UK government bonds because there was more potential for BOE rate cuts ahead.
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Doves fly
Britain’s exporter-focused FTSE 100 hit a new record high after the BOE meeting. Europe’s Stoxx 600 index is up 2 per cent so far this week, poised for its best week since January.
Money markets are pricing in around 55 basis points (bps) of BOE rate cuts in total by year-end, 70 bps from the ECB and just 43 bps from a Fed still grappling with strong inflation.
Economists polled by Reuters expect the US economy to expand by 2.5 per cent this year, versus 0.5 per cent in the eurozone and 0.4 per cent in the UK, as lavish government spending dubbed “Bidenomics” spurs investment but raises debt and the deficit.
In terms of growth momentum, investors see Europe doing better, boding well for assets in the region over the longer term.
“Europe is really accelerating, albeit from a weaker base at a time where the US economy is cooling from a stronger starting point,” said Hugh Gimber, global market strategist at JP Morgan Asset Management.
Investors are querying whether the US will run out of steam, other strategists said.
But in the short term, if the US can run up its debt and its deficit, then rates in the US will likely stay higher than in Europe, said Societe Generale strategist Kit Juckes.
Risky pivots
European government bonds could outperform the US but are likely to stay volatile as the inflation path worldwide remains unpredictable, investors and analysts said.
The BOE, the ECB and other European central banks might regret sounding too dovish too soon, Lombard Odier’s Ielpo said.
In the US, the Fed sent a strong signal in December that rate cuts were coming but then turned more hawkish after financial conditions became euphoric and inflation stalled above its target.
UK gilts have lost investors 3.1 per cent, this year, compared with 2.1 per cent losses in the US and 1.2 per cent in the eurozone, based on LSEG data.
BlueBay Asset Management portfolio manager Neil Mehta said the firm does not like bonds in the UK, partly because of relatively high inflation.
The yield on Britain’s rate-sensitive two-year gilt slipped 3 bps after the BOE decision to 4.28 per cent as debt prices firmed slightly.
The BOE last diverged significantly from Fed policy in August 2016, when it cut rates by a quarter point to insulate the economy from Brexit while the Fed was on hold and preparing to raise.
The ECB was a holdout dove with rates below zero from 2014 to 2022 but has followed the Fed since.
The divergence theme would mostly play out in currency markets, Mehta added, with the dollar staying strong, in a further risk for inflation in Europe as import prices rise. The euro is down 2.6 per cent so far this year to US$1.07, Sterling is down roughly 2 per cent.
Matthew Swannell, economist at BNP Paribas, said this was not a particular risk for UK, whose biggest trading partner is the European Union.
“So we do think the Bank of England can move before the Federal Reserve, and likewise the ECB (can too),” he said. REUTERS
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