Navigating shifts: 2024 elections

Market recap

• Elections remain front and centre in 2024. Centrist parties held control of the European Parliament in June elections, though right-wing and anti-establishment parties gained ground. In the UK, the Labour Party won by a landslide, while France’s unprecedented election outcome could lead to a left-wing coalition in parliament. Going forward, attention will also shift to the lead-up to the U.S. elections.

• The U.S’ economy remains robust, with GDP growth revised upward to 2.5% for 2024. This growth is supported by strong consumer spending and a sturdy labour market. However, inflation persists above the Federal Reserve’s (Fed) 2% target. To manage this, the Fed is expected to implement rate cuts of 75 basis points (bps) by year end, beginning in the summer. These adjustments aim to address inflation while sustaining economic growth.
• In the euro area, the region has started to emerge from stagnation, with GDP growth projected at 1.4% for 2024. This recovery is bolstered by improved household incomes and favourable global economic conditions. The European Central Bank (ECB) commenced an easing cycle, starting with an initial 25 bps cut, and anticipates further cuts throughout the year and into 2025. Despite these positive developments, high labour costs and sluggish productivity remain significant challenges that the region must address to sustain long-term growth. Similarly, the UK’s economy has shown signs of recovery, with a GDP growth rate of 0.6% in Q1, 2024. The services sector and recovering real incomes drive this growth

Q2 highlights

• The Bank of England (BoE) is expected to begin cutting rates in August, with total reductions anticipated to reach one percentage point by the end of 2025. While inflation is projected to reach target levels by early 2025, core inflation may take longer to stabilise, indicating a cautious yet hopeful outlook for the UK economy.
• Each central bank's approach to rate cuts varies in timing and magnitude, reflecting tailored strategies to their unique economic conditions. Increased consumer spending and business investment are notable contributors to economic resilience, underscoring the importance of maintaining consumer and business confidence. However, the global economic outlook is not without risks. Geopolitical tensions and energy price fluctuations remain significant concerns that could impact economic stability and growth.
• Sectoral growth varies, with the services sector in the UK and industrial production in the U.S. standing out as key drivers of their respective economic recoveries.

The eurozone economy has shown improvement following a challenging 2023. The impact of higher living costs is easing, economic growth has surpassed expectations, labour market remains strong, and the European Central Bank has begun reducing interest rates.

According to a preliminary estimate from Eurostat, the statistical office of the European Union (EU), annual inflation in the euro area is expected to be 2.5% in June 2024, slightly lower than May's 2.6%. Services are anticipated to lead with a stable annual rate of 4.1% in June.

In Q1, 2024, the Euro area’s GDP expanded by 0.3% compared to the previous quarter. (Chart 3). The unemployment rate in the euro area held steady at 6.4% in May, maintaining its average of 9.3% since 1995. In recent European parliamentary elections, voters in France and Germany delivered significant setbacks to their leaders. This led Emmanuel Macron to call for a snap legislative ballot after the far-right National Rally made substantial gains in the initial round. In Germany, Chancellor Olaf Scholz's Social Democrats faced their worst-ever electoral outcome, trailing both the opposition conservatives and the far-right alternative for Germany. The recent French parliamentary elections resulted in no party achieving an absolute majority, with the leftwing New Popular Front securing the most seats, followed by President Macron's centrist alliance and the National Rally.

This unexpected outcome has left France in a state of political uncertainty, with potential scenarios including a left-led minority government, a technocratic government appointed by Macron, or prolonged negotiations to form a working majority, all of which could impact French government bonds and the country's influence within the EU.

On the policy front, the ECB initiated an easing cycle with a 0.25 percentage point cut in June. Key rates now stand at 4.25% for main refinancing operations, 4.50% for the marginal lending facility, and 3.75% for the deposit facility. This decision reflects growing confidence in future economic prospects, although future decisions will continue to hinge on data and forecasts. President Lagarde reiterated that the Governing Council is not committing to a specific rate trajectory. Notably, the market has priced in one rate cut for October, with expectations of a total 44 basis points cut by the end of 2024. Similar cuts are anticipated quarterly, with two more expected by June 2025, potentially reducing the policy rate to 3% by mid-year 2025. (Table p.3) During the same period, European yields declined, with the 3-month Euro short-term rate (ESTER) dropping by 22.4 basis points, the 6-month rate by 17.8 basis points, and the 12-month rate by 7.9 basis points compared to the previous quarter, ending at 3.63%, 3.53%, and 3.33%, respectively.

In recent months, the UK economic landscape has shown resilience and cautious optimism.

In the 12 months leading up to May 2024, the Consumer Prices Index (CPI) increased by 2%, down from 2.3% in April and well below its peak of 11.1% in October 2022. Regular earnings (excluding bonuses) saw annual growth of 6% from February to April 2024, consistent with the previous three-month period.

The S&P Global UK Manufacturing PMI fell to 50.9 in June 2024 from 51.2 in May but remained above March's 50.3. This indicates ongoing growth in the manufacturing sector, with output and new orders expanding for the second consecutive month, albeit at rates similar to those in May. The UK Services PMI also declined to 52.1 in June 2024 from 52.9 in May, continuing a trend of expansion in the services sector for the eighth consecutive month, albeit at the slowest pace this year.

On 22 May, Rishi Sunak requested permission from the King to dissolve parliament and announced a general election to be held on 4 July. Parliament was prorogued on 24 May and dissolved on 30 May, with the vote scheduled for 25 working days later. The UK’s Labour Party, led by Keir Starmer, won a decisive victory in the General Election, providing a strong mandate to address structural issues including weak productivity and labour shortages. With a substantial majority, Labour is poised for a possible two-term government, focusing on longterm policy implementation, investment attraction, and productivity improvements, while fostering better relations with the EU and maintaining fiscal discipline amid economic challenges.

During the quarter, the Bank of England maintained its policy rate at 5.25%, aligning with market expectations. The Bank may follow the ECB in cutting rates, contingent on continued progress in combating inflation. No press conference followed the release of the meeting minutes in June, as communication outside of the post-meeting statement is restricted by rules related to the upcoming election. While the BoE anticipates inflation to rise, the term "finely balanced" and references to "members" indicate some policymakers are undecided. Should inflation data in the second quarter significantly undershoot expectations, there is a possibility of an earlier-than expected rate cut. Based on OIS market pricing, there is a 60% chance of a rate cut in August and a 96% chance in September by the end of June 2024.

The focus has shifted in the US market as the Fed reached terminal rates and investors await a potential easing.

At the ECB’s Forum on Central Banking in Sintra, Fed’s Chair Powell observed that the inflation figures for the previous two months (Chart 9) show a reversal to a downward trend in inflation. If data continues to show further disinflation and slowing growth, it is anticipated that the Fed could become confident enough to initiate maintenance cuts starting at their September meeting. The June Federal Open Market Committee’s (FOMC) meeting minutes highlighted that participants pointed out various factors likely to contribute to continued disinflation in the coming period. These factors include ongoing easing of demand-supply pressures, delayed effects of past monetary policy tightening on wages and prices, and the lagged response of shelter prices to rental market changes. The Committee is evaluating comprehensive data rather than focusing solely on individual inflation readings. Given recent data, the June Summary of Economic Projections (SEP) now appears somewhat outdated, with a median GDP projection of 2.1%.

The labour market has achieved a better balance with reduced concerns of overheating. Despite robust nonfarm payroll gains, several participants suggested that the Establishment survey may overstate strength, a view supported by various U.S. hiring indicators.

Encouraging inflation developments in 2023, along with improved April and May core Personal Consumption Expenditures (PCE) readings collectively indicate an ongoing, albeit uneven, disinflationary process. Annual Core PCE fell to its lowest since March 2021, down to 2.6% from 2.8%.

The Committee is attuned to slowing growth indicators and corroborating feedback from business contacts, underscoring their attention to balanced risks. The focus now shifts to forthcoming reports to bolster confidence in achieving sustainable inflation near 2%. Based on market pricing of OIS, the probability of the first rate cut in September ~61% odds, with the first full cut still fully priced for November.