The European Central Bank Could Hold Out On Summertime Rate Cuts

The European Central Bank Could Hold Out On Summertime Rate Cuts
Paul Allison, CFA

about 1 month ago2 mins

What’s going on here?

The European Central Bank (ECB) stressed that summertime interest rate cuts are likely, but far from guaranteed.

What does this mean?

The ECB’s thick-and-fast rate hikes successfully made it more expensive for folk and companies to borrow money, making them more likely to save cash than spend it. The pro: with retailers making less cash from sales, they’ve been pushed to lower their prices, bringing down inflation. The con: those squashed sales mean European economies have suffered. So with inflation finally taking a breather, investors have been betting that the ECB will cut rates six whole times this year. That would bring them closer to their starting point and hopefully spark enough spending to spur on major economies. But on Wednesday, the ECB said that approach would be hasty: inflation gauges aren’t all in the sweet spot yet, making the results of any drastic moves too unpredictable to risk.

UK inflation
Source: Office for National Statistics

Why should I care?

For markets: Careful what you wish for.

Ironically, though, investors’ expectations tend to be self-defeating. Interest rates and bond prices have an inverse relationship, with one rising when the other falls. So when investors start to bake their rate-cut predictions into their trades, bond prices rise. That lowers the interest rate attached to government bonds, the ones that set the price for major loans like mortgages. So suddenly, it’s cheaper for folk to borrow – and therefore, spend – money, all because of expectations, which makes actual central bank cuts less likely.

The bigger picture: A broken clock is right twice a day.

Mind you, big-picture predictions have a history of inaccuracy. For years, investors were predicting near-zero interest rates to be pulled up, only to be continually proven wrong. Then when rate hikes did happen, they played out a lot faster than self-proclaimed market psychics expected. So while they might be right about looming rate cuts, don’t count on anyone to nail the precise details.

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