Stocks march as they see fit as other financial markets scale back hopes of rate cuts – The Irish Times

Belgium's central bank governor Pierre Wunsch has yet to see a microphone he doesn't like since he was installed for a second term last month – after political wrangling in the country's seven-party coalition over various posts led to a collapse had a bizarre 10-day delay in his reappointment.

Wunsch, who has been a member of the Council of the European Central Bank (ECB) since taking office in 2019, has given speeches in the last three weeks and has also written an article for a European financial think tank.

The tone has become increasingly hawkish over the period, from calls on February 8 for “more data” before the ECB cuts rates to warnings this week that official borrowing costs will remain higher for “longer than currently expected.” could.

The Governing Council may have 26 members, but some voices – like Wunsch's – carry more weight than others. He was among the first at the table in Frankfurt to call for tighter monetary policy in 2021, while most others, including ECB President Christine Lagarde, insisted that any rise in inflation at this point would be temporary.

The ECB only began raising interest rates in July 2022. However, it was on the decline and had to increase its deposit interest rate from minus 0.5 percent to 4 percent within 15 months.

Inflation in the euro zone fell from a peak of 10.6 percent at the end of 2022 to 2.8 percent last month. However, a survey released by the ECB on Friday shows consumers are cautious about the prospect of price growth slowing to the central bank's 2 percent target soon. The average expectation of 19,000 adults in euro area countries is that inflation will be 3.3 percent in one year and around 2.5 percent in three years.

This time, Wunsch is not an outsider in the government council. German Bundesbank President Joachim Nagel and his Austrian counterpart Robert Holzmann were the latest to dampen hopes of a rate cut on Friday.

In the US this week, the release of minutes from the Federal Reserve's monetary policy committee meeting at the end of January highlighted the risk that key interest rates could be cut too quickly from a 22-year high of 5.25 to 5.5 percent Cent. According to figures released last week, U.S. inflation was above expectations at 3.1 percent in January (compared to a peak of over 9 percent in mid-2022).

There are many warnings from history that the final phase of inflation's return to central bank targets is often the most difficult.

“The closer inflation gets back to target, the greater the pressure to ease policy, increasing the risk of acting too soon and causing inflation to rise again,” Henry Allen, a strategist at Deutsche Bank, said this week in a report.

“Even the expectation of future interest rate cuts can ease financial conditions, which in turn increases inflationary pressures.” That's something we've seen in 2024, where the overwhelming consensus is that major central banks like the Fed and ECB will have their next one The move will be a rate cut rather than an increase.”

When inflation is triggered by a shock – such as the release of pent-up demand after the worst outbreak of the pandemic, followed by supply chain disruptions and Russia's invasion of Ukraine sending energy prices soaring – then the… Immediate effects can wear off fairly quickly. The problem is that shocks have second-round effects, as is the case now.

“Initially, inflation was driven by goods and more volatile components of the consumer basket such as energy,” Allen said. “But increasingly it is the 'stickier' categories such as services that are keeping inflation high, which can decline much more slowly once it rises.”

Even more worryingly, the longer price growth stays above target, the harder it is to eradicate it, as it leads to higher inflation expectations, which become a self-fulfilling prophecy.

James McCann, deputy chief economist at British investment giant Abrdn, said in a podcast on Thursday that the Fed – whose dual mandate is to achieve maximum employment and keep prices stable – may feel it has the “luxury” There is “We will be more cautious in the last mile of inflation and keep monetary policy tight for a little longer,” because the labor market remains strong.

Short-term debt markets, which earlier this month priced in ECB rate cuts of 150 basis points – or 1.5 percentage points – this year, have significantly scaled back their expectations as they heed increasingly hawkish tones from tariff politicians on both sides of the aisle Atlantic. The money markets were now expecting discounts of less than 100 basis points.

U.S. debt derivatives markets now expect four quarter-point interest rate cuts from the Fed this year, compared with six moves predicted a month ago.

However, the stock markets are hitting a different beat: the pan-European Stoxx 600 index and the Wall Street S&P 500 reached a record high on Friday.

To be sure, this week's rise was fueled by a buying spree after California-based Nvidia, the dominant player in the global artificial intelligence (AI) chip market, posted better-than-expected quarterly sales.

But even before Nvidia reported, stocks weren't cheap: The S&P 500 was trading at 20 times this year's expected earnings of its partner companies – compared to an average multiple over the last decade of about 16. The Stoxx 600 index in Europe was The company traded at 14 times earnings, above its long-term average of 13, amid hopes for a soft landing.

This is a desirable scenario in which inflation and interest rates ease from now on and a deep global recession is averted.

Will Inflation's Difficult Last Mile Overtake Stock Markets?