The European Central Bank changes course.
As expected, the European Central Bank (ECB) carried out an initial rate cut – of 25 bps to 3.75% – at its meeting on 6 June. The ECB may have got in there before the Fed but it was by no means the first – the Swiss National Bank, Sweden’s Riksbank and the Bank of Canada all lowered rates earlier. It’s interesting that the ECB cut rates while also raising its inflation forecast, probably in response to May’s consumer price figures. We think this cut marks the start of a new cycle of monetary policy easing. Annual core inflation has dropped below 3%, which is almost a whole percentage point below the US figure. And it should be pushed down further by slower wage growth and the fact that there’s unlikely to be any more fiscal stimulus. As always at the press conference, Christine Lagarde adopted a cautious stance and gave nothing away about future rate cuts, in order to keep expectations in check.
This rate cut is great news for the eurozone. Economic growth has started to recover and should pick up pace in the second half of the year, barring any external shocks. Disinflation will ease the pressure on consumers’ wallets, a decline in energy prices will boost manufacturing, and lower interest rates will lead to looser financial conditions and spur lending.
And there’s even more good news: falling interest rates will also be a boon for risk assets, especially European equities. If history is anything to go by, stock markets gain ground when interest rates are lowered. Various studies have shown that stock markets go up by an average of 6% in the first six months following an initial rate cut and 10% in the first 12 months. On top of that, declining rates coupled with an uptick in economic growth is a particularly good combination. It’s hard not to be bullish on European equities, even though the current consolidation could go on for some time as a result of the political uncertainty sparked by the European elections.
Risk premiums left unscathed by European elections
Europe’s bond market remained relatively unfazed by the strong rise in eurosceptic parties in the European elections, with yield spreads between peripheral countries and Germany up by less than 10 basis points. And despite the landslide by France’s National Rally party, the risk premium on French bonds relative to the region’s risk-free bonds – the 10-year German Bund – followed a similar trend. These nationalist parties are no longer looking to get rid of the euro, which is almost certainly why there was very little reaction from bond investors. The single currency did lose some ground over the past few days, but that probably has more to do with the European Central Bank’s decision to begin loosening its monetary policy, at a time when it looks like the US Federal Reserve will have to keep its interest rates high for a while longer.
This week's figure : 31.5%
This is the record share of the vote obtained by France’s far-right National Rally party in the European elections. In response, Emmanuel Macron has dissolved the country’s National Assembly and called early parliamentary elections.
Author
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Daniel Varela holds a degree in business administration with a specialisation in finance from the University of Geneva and began his career in 1989 as a fixed income manager. He joined Banque Piguet & Cie in 1999 as head of institutional asset management and with responsibility for bond analysis and management. In 2011, he became head of the investment strategy and Piguet Galland's investment department. In 2012, he joined Piguet Galland's Executive Committee as CIO.
