Stocks drop as ECB and UK inflation puncture rate cut hopes

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European stocks and bonds fell after European Central Bank president Christine Lagarde signalled that interest rates would come down in summer rather than spring and UK inflation rose unexpectedly for the first time in 10 months.

The region-wide Stoxx Europe 600 fell 1.2 per cent shortly after Lagarde said that market expectations for an ECB rate cut this spring were “not helping” the fight against inflation.

Asked if she agreed with fellow ECB governing council members who have signalled a rate cut is expected this summer, Lagarde said: “I would say it is likely too, but I have to be reserved.” 

Her comments came as London’s FTSE 100 fell 1.6 per cent after UK inflation increased to 4 per cent in December, prompting traders to scale back their bets on Bank of England rate cuts.

December’s figure exceeded the 3.8 per cent forecast by economists in a Reuters poll and was the first rise in UK inflation since February 2023.

Lagarde told Bloomberg TV at the World Economic Forum that the ECB would have information it required on wage pressures by “late spring”. Such data would be necessary before any decision to lower borrowing costs.

“It now seems that hopes for early cuts in rates from global central banks were a tad optimistic,” said Charles Hepworth, investment director at GAM Investments.

As European stocks reacted to the prospect of interest rate cuts later than previously expected, rate-sensitive real estate groups were among the worst performers. France’s Cac 40 dropped 1.1 per cent, while Germany’s Dax slipped 1 per cent.

Bond markets were also hit by a sell off, with UK 10-year bond yields, which move inversely to prices, climbing 0.07 percentage points to 3.87 per cent.

Before Lagarde spoke markets had fully priced in a cut to the ECB’s record high benchmark interest rate of 4 per cent by April, attributing a 30 per cent likelihood to a cut in March.

Those probabilities slipped after her comments to 95 per cent for a cut by April and 20 per cent for a reduction in March.

Matthew Landon, global market strategist at JPMorgan Private Bank, warned that Wednesday’s UK inflation figures would also almost certainly delay a policy pivot from the Bank of England: “markets may be too enthusiastic about how many cuts the [BoE] can manage this year.”

Germany’s rate-sensitive two-year bond yield rose 0.04 percentage points to 2.63 per cent on Wednesday, its highest since early December.

Prices of government debt had already been hit after US Federal Reserve board member Christopher Waller warned on Tuesday that the US central bank should also not rush to slash rates, saying policymakers should “take our time to make sure we do this right”.

Speaking a day before the ECB’s quiet period starts ahead of its next meeting on January 25, Lagarde said she was increasingly confident that eurozone inflation would sustainably drop to the ECB’s 2 per cent target in the medium term. Annual price growth in the bloc has slowed from a peak of 10.6 per cent in October 2022 to 2.9 per cent last month. 

But the ECB president warned inflation was still too high in the labour-intensive services sector — at 4 per cent in December — and there was a risk of high wage growth, which pushed up pay per eurozone employee 5.2 per cent last year, keeping price pressures too high.

“Short of another major shock we have reached a peak” in interest rates, she said. “But we have to stay restrictive for as long as necessary” to ensure inflation keeps falling. “The risk would be we go too fast [on rate cuts] and have to come back and do more [rate increases].”

Her comments were backed up by Klaas Knot, head of the Dutch central bank and a member of the ECB rate-setting governing council, who told CNBC on Wednesday: “The more easing the markets has already done for us, the less likely we will cut rates, the less likely we’ll add to it.”

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