Economic turbulence: Central banks and political shifts

Market recap

• In 2024, around 40% of the population are expected to participate in elections, marking the largest demonstration of political will in history. So far, the sentiments from this vast global electorate have been diverse, with several far-right parties achieving victories across Europe.
• In Q3, ongoing global events like the conflict in Ukraine and tensions in various regions continued to influence the eurozone economy.
• In response to economic conditions, central banks have taken decisive actions. The Federal Reserve, for instance, has cut interest rates by a substantial 0.50% in September, reflecting their responsiveness to recent labour market trends and inflation concerns. Markets anticipate further rate cuts by the end of the year.
• The European Central Bank (ECB) and the Bank of England (BoE) have also lowered rates, responding to slowing growth and wage growth moderation. These actions are aimed at supporting economic momentum.
• Financial markets have reacted with cautious optimism, interpreting these moves as potentially stimulating consumer spending and investment. However, uncertainties persist, particularly regarding the economic outlook and policy directions.
• While global growth is moderating, it remains resilient, and inflation trends are aligning with central banks' targets. This environment suggests a supportive stance from central banks globally, aimed at maintaining economic stability amid ongoing challenges.

Q3 revealed a cautious economic landscape in the Euro Area, characterized by declining inflation, stagnant growth, and strategic monetary policy adjustments aimed at supporting recovery.

The disinflation trend has been confirmed with the last CPI print coming in below the ECB target at 1.8% in September (Core 2.7%), and ECB projections showing 2-year (2026) inflation at 1.9%, below its inflation target.

GDP growth remained stable at 0.30% for the second quarter, signalling resilience amidst tightening financial conditions and previous energy price spikes.

The Eurozone Composite PMI showed signs of a slowing economy, adjusting to 49.6 in September, indicating a contraction in business activity for the first time since February. Notably, the services sector experienced a slowdown, while manufacturing faced deepening contractions.

In Q3, the European Central Bank (ECB) took decisive actions in its monetary policy to address evolving economic conditions. Following an initial rate cut in June, the ECB reduced the deposit facility rate by 0.25% during its September meeting, bringing it down to 3.50%. Consequently, the main refinancing rate and the marginal lending rate were adjusted to 3.65% and 3.90%, respectively. The market was increasingly confident in further rate reductions, with expectations for a total of 55 basis points in cuts by the end of 2024, taking the deposit rate to 2.86% by end of 2024.

European yield indicators demonstrated declines in short-term rates, with the 3-month, 6-month, and 12-month Euro short-term rates (Ester) ending September at 3.20%, 2.94%, and 2.47%, respectively. These movements underscore the market's anticipation of continued monetary easing as the ECB navigates complex economic dynamics.

By the end of Q3, the market was pricing in a complete certainty (94%) of a 25 basis point rate cut in October, driven by the ongoing assessment of economic indicators and inflation trends.

The UK's economy shrank in Q4, 2023, marking the second consecutive quarter of contraction.

UK inflation dipped below the BoE’s 2% target for the first time in over three years. In September, consumer prices rose by 1.7% year-on-year, down from 2.2% in August 2024.

Meanwhile, the UK's PMI fell to 52.6 in September 2024, down from 53.8 in August, revised from an initial estimate of 52.9 and below market expectations of 53.5. Despite this decline, the PMI indicates that private-sector activity in the UK has maintained robust momentum for the 11th consecutive month. This trend highlights the contrast between the UK's growth and the contraction occurring in the Eurozone, supported by both the services sector (52.4, down from 53.7 in August) and the manufacturing sector (51.5, down from 52.5).

The British economy grew by 0.5% in Q2 2024, a slight decrease from the initial estimate of 0.6% and down from 0.7% in Q1. While government spending and exports were revised downward, there was an increase in investment.

In August, the BoE’s Monetary Policy Committee (MPC), made a close call, voting 5-4 to cut the Bank Rate by 25 basis points down to 5.00%. Some members felt it was time to ease up on policy a bit, thanks to a decrease in external shocks and progress in reducing inflation risks. However, four members disagreed, pointing out worries about services inflation, stronger-than-expected GDP growth, and persistent domestic inflation pressures. They forecasted inflation to rise to around 2.75% this year due to energy base effects but expected it to drop back to the 2% target in two years.

Fast forward to September, and the BOE decided to hold rates steady at 5%, though one member pushed for a 25 basis point (bps) cut. The committee reiterated the need to be cautious about cutting rates too much or too quickly.

The UK has been doing better than Europe, but inflation is decreasing at a slower pace, which has some BoE members feeling cautious. Still, toward the end of September, the BoE's governor, Andrew Bailey, hinted that there could be room for more aggressive rate cuts.

Overall, the BoE remains one of the least dovish central banks in the G10, which has helped the money market curve by preventing it from inverting too much, keeping it among the least inverted curves in major markets.

At the end of September, the market was pricing in 24 bps cut in November, with a total of 37 bps by the end of the year and 138 bps over the next 12 months.

Information contained in the Federal Open Market Committee’s (FOMC, the Committee, or the Fed) Summary of Economic Projections (SEP) released at the September FOMC meeting reflected a projection of two additional 0.25% interest rate cuts over the balance of 2024, and additional cuts totalling 1.00% in 2025 and 0.50% in 2026. The SEP also forecasted modestly lower inflation and an upturn in the unemployment rate in 2024.

In turn, we believe the FOMC will continue to move to adjust the federal funds target range lower at upcoming meetings should data continue to point to a continued easing in price pressures and a further softening in labour market conditions and expect the size and timing of future adjustments will remain ‘data dependent.’

The FOMC lowered the federal funds rate by 0.50% to a range of 4.75% to 5.00%, the first change in its key policy rate since July 2023 and the first reduction since March 2020. One member of the Committee dissented in favor of a 0.25% cut.

The statement1 released in conjunction with the meeting was revised to acknowledge “greater confidence that inflation is moving sustainably toward” the Committee’s 2.00% goal, and that the FOMC now sees “risks to achieving its employment and inflation goals” as “roughly in balance.”
Guidance about the path of policy was unchanged, with the Committee noting that additional changes in the federal funds target range would be based on an assessment of various factors including incoming data.

The statement was also revised to note that the FOMC is “strongly committed to supporting maximum employment” while retaining their comparable focus on bringing inflation back to its 2.00% goal.

The median federal funds rate forecast contained in the SEP2 released in conjunction with the FOMC meeting for 2024 fell to 4.40%, implying, in our estimation, two additional cuts of 0.25% over the balance of 2024.

The updated SEP for 2024 reflected slightly lower core inflation and economic growth forecasts, and a higher unemployment projection relative to June. Core inflation is still not projected to fall to the FOMC’s 2.00% objective until 2026.