Rate cuts to start in June

It’s been a long wait but it’s odds on that we will get a rate cut from the European Central Bank when they meet on the 6^th June. There’s also a reasonable chance that the Bank of England will join the party on 20^th June. But the big question is whether the US Federal Reserve cut in June too. That in turn requires the inflation data to behave with the prospect of a significant slowdown in the US economy adding to the chances of a cut.

Having enjoyed a faster fall in inflation when price pressures peaked, the disinflation process has recently stalled in the US. Core inflation is now lower in the Eurozone and the gap with the UK is closing fast. As we’ve explained in previous updates, we think that the US economy is slowing as the consumer retrenches. That in turn should put US inflation back on a downward path. The question is when this will show up in the inflation figures which have generally disappointed so far in 2024. We think that there is a reasonable chance that the data will allow the Federal Reserve to cut in June, but the prospects are clearer in the UK and crystal clear in the Eurozone.

One of the biggest barriers to US disinflation is rental growth. This has been running at around 6% and, with an excessive weight on shelter in the US – it accounts for 36% of the index – there needs to be a slowdown here if there is to be any chance of hitting the 2% target. One bit of good news is that the Federal Reserve target the personal consumers expenditure deflator which has a lower weight on shelter but at 18%, it’s still double the weight in similar indices in Europe and the UK.  Getting inflation down to target could therefore be a more drawn-out process in the US, in large part because of their distinctly odd treatment of rent: in addition to actual rents, they include the rent that owner occupiers would pay if they rented their house from themselves.

Growth has been much stronger in the US than in the UK and Eurozone but that too is changing. UK growth surged in Q1 and should stay strong as consumer confidence improves and spending increases in line with risking real incomes. A similar pattern is evident in the Eurozone though the pick-up is proceeding more slowly.

All in all there are significant changes taking place in the world economy. Global recovery is underway but it is no longer led by the US. Inflation is coming under control but the final mile to 2% is harder work in the US than in Europe and the UK. Steady growth with falling inflation and lower interest rates is the goldilocks scenario. If it comes to pass as we think, that would be a positive background for financial markets.