By Naomi Rovnick
LONDON, March 21 (Reuters) – As Switzerland implemented a surprise rate cut on Thursday, markets have swiftly pivoted towards anticipating significant reductions in borrowing costs by major central banks. While this move by the Swiss National Bank (SNB) has elicited a wave of responses from traders, propelling government borrowing costs lower across Europe as the Stoxx 600 share index reached a fresh record, analysts are pointing out complexities that other central banks may encounter in their decision to relax the inflation fight.
Anticipation and Caution in the Air
While the U.S. Federal Reserve’s stance on rate cuts remains uncertain, given the elevated inflation in the country, investors have embraced the Swiss decision as a key indicator. The considerable bets being placed indicate a strong expectation for rate cuts from the European Central Bank (ECB) and the Bank of England (BoE) in June.
Some analysts have warned that these central banks may be at risk of triggering inflationary currency devaluation in a scenario where they act too swiftly before the Federal Reserve. As Chris Jeffrey, head of macro strategy at Legal & General Investment Management, pointed out, Switzerland’s move marks a critical shift that cannot be overlooked.
Money markets are now pricing in a 90% chance of an ECB rate cut by June, up from less than 80% just a day earlier. Similarly, expectations for a June cut by the BoE have surged to about 70% from under 60%. The BoE decided to maintain its rates at a 16-year high of 5.25% on Thursday but hinted at an impending change, signifying a move in the right direction for potential cuts.
Unlike the UK and the eurozone, Switzerland boasts a headline inflation rate of 1.2% in February, comfortably within the SNB’s 0-2% target range. Nikolay Markov, senior economist at Pictet Asset Management and an ex-SNB employee, emphasized that Switzerland’s situation is quite distinctive among major central banks due to its early initiation of the easing cycle in response to concerns about the persistent deflationary impacts of a strengthening Swiss franc.
The Ripple Effects of a Unique Step
The Swiss franc, which experienced a notable 6% surge against the euro last year, saw a decline following the SNB’s rate cut, weakening against both the euro and the dollar as the rate gap between Switzerland and its peers widened.
Post the BoE meeting, the yield on the British two-year gilt, highly sensitive to interest rates, dropped by 12 bps to 4.23%, signaling a positive trajectory in bond prices and marking its most robust daily performance in almost a month. Similarly, Germany’s equivalent bond yield declined by 6 bps to just above 2.9%, showcasing the traditional tendency of bonds to benefit from lower rates by enhancing the real income return from fixed interest-paying securities.
Amidst Enthusiasm, Words of Caution Prevail
Salman Ahmed, global head of macro and strategic asset allocation at Fidelity International, warned that the Fed might delay its rate cuts, presenting a different stance from the ECB and the BoE, which could risk currency devaluation and increased inflation levels by acting first. Despite the U.S. inflation data for February exceeding expectations, the Fed maintained its projections for three 25 bps rate cuts in 2024 while boosting its economic growth forecasts notably.
Ahmed highlighted the dilemma faced by the ECB with potential FX fluctuations and emphasized the challenges that a weak pound could pose in terms of inflation for the BoE. Although UK inflation cooled to 3.4% in February, it remained above the BoE’s 2% target, indicating a delicate balancing act in the upcoming monetary policy decisions.
Investors have shown a keen interest in acquiring UK and European government debt, anticipating rate cuts regardless of the precise timing. With expectations of falling yields in Europe, Joost van Leenders, senior investment strategist at Van Lanschot Kempen in Holland, mentioned the strategic shift towards euro zone bond exposure to capitalize on the emerging trends.
Regardless of the outcome of the first cut in Europe, the trajectory of rates appears headed downwards, offering compelling opportunities for investors to navigate the evolving market landscape.
The race to cut rates has started https://reut.rs/3PyuwAO
Swiss National Bank makes surprise rate cut https://reut.rs/43up87h
BoE keeps Bank Rate unchanged https://reut.rs/4a4B5Di
(Reporting by Naomi Rovnick; editing by Dhara Ranasinghe and Toby Chopra)
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