The Bank of England (BoE) has indicated that borrowing costs are likely to decrease sooner and more significantly in Europe compared to the United States.
This forecast is setting the stage for major market adjustments as a monetary policy divergence appears between the two regions.
European stocks and debt are poised to lead global markets this year, spurred by anticipated interest rate cuts that are expected to boost consumer spending, improve bond markets with softening inflation, and enhance exports due to weaker currencies.
On Thursday, the BoE maintained its interest rate at a 16-year high of 5.25% but revised its inflation forecasts downward. This decision resulted in a drop in sterling and a rally in stock prices.
This follows interest rate cuts by Sweden—the first since 2016—and Switzerland in March.
The European Central Bank (ECB) has also hinted at a potential rate reduction in June. Conversely, the U.S. Federal Reserve is expected to maintain higher rates for a longer period.
Florian Ielpo of Lombard Odier Investment Management and Paul Flood from Newton Investment Management have expressed optimism about European and UK equities.
Flood is particularly positive about UK government bonds, citing further potential for BoE rate reductions.
The British exporter-heavy FTSE 100 achieved a new record high post-BoE announcement, while Europe’s Stoxx 600 index surged 2% for the week, marking its best performance since January.
Market projections suggest about 55 basis points (bps) of total BoE rate cuts by the end of the year, compared to 70 bps from the ECB and only 43 bps from the Fed, which continues to combat persistent inflation.
Despite slower expected growth in Europe—with the eurozone and the UK projected to expand by only 0.5% and 0.4% respectively, compared to 2.5% in the U.S.—investors remain optimistic about Europe’s market trajectory over the long term.
According to Hugh Gimber of J.P. Morgan Asset Management, Europe is gaining momentum from a weaker starting point, contrasting with the cooling U.S. economy.
Investors are speculating whether the U.S. might exhaust its economic energy, especially as high debt and deficits persist, spurred by “Bidenomics.” Kit Juckes from Societe Generale suggested that if the U.S. continues to increase its debt and deficit, its interest rates are likely to remain higher than those in Europe.
In the bond markets, European government bonds may outperform their U.S. counterparts but could remain volatile given the uncertain global inflation trajectory.
The more dovish stance by European central banks could be premature, warned Ielpo.
Neil Mehta of BlueBay Asset Management is not favoring UK bonds due to relatively high inflation. After the BoE’s decision, the yield on Britain’s two-year gilt slightly decreased.
The monetary policies of the BoE and ECB are diverging from the Fed, influencing currency markets, with the euro and sterling both experiencing declines this year.
This divergence could increase inflationary pressures in Europe due to rising import prices, according to strategists.