Interest rates, growth and financial markets
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Interest rates, growth and financial markets

US is on course for ‘immaculate disinflation’; UK and Europe to follow suit.

High employment and the absence of significant economic contraction has removed pressure on central banks to cut interest rates as headline inflation falls. Instead, they can wait for wage inflation to fall to the 3-4% level consistent with their long-term 2% inflation targets.

We think that US wage inflation is already at these levels so, when the figures come through, the Federal Reserve (Fed) will be first to cut. The European Central Bank (ECB) should also see better news on wages ahead of their June meeting. The Bank of England is set to lag, as wage inflation remains high even as headline consumer inflation falls sharply.

However, delays of a few months to the start of interest rate cuts may not matter much to markets and consumers if long-term interest rates come down in anticipation of an extended cycle of interest rate cuts. We therefore continue to forecast a pickup in economic growth. While bond valuations are attractive, the combination of rate cuts and economic growth will also support gains in the equity market.

Figure 1: Core inflation falling fast
core inflation falling fast
Source: Columbia Threadneedle Investments and Bloomberg as at 26 February 2024

US is on course for ‘immaculate disinflation’

The US economy is seeing some headwinds, such as a rebound of bond yields eroding previous mortgage rate cuts. That has dampened consumer confidence and, while the Purchasing Manager Indices (PMIs) remain positive, there is little sign of reacceleration.

However, the weaker patches of the US economy may help keep wage inflation down. As a consequence, the Fed is set to lead developed economies in cutting interest rates. The economy will also be supported by the virtuous cycle of falling inflation driving real income gains, while moderating wage demands help sustain lower inflation and provide headroom for interest rate cuts.

Figure 2: Composite Purchasing Manager's Indices
composite purchasing manager's indice's
Source: Columbia Threadneedle Investments and Bloomberg as at 26 February 2024

We forecast a dramatic recovery for the UK economy.

While we disagree with the ‘technical recession’ description, the UK economy has been through a dismal period. However, the PMIs indicate that growth has already resumed. We believe this recovery will be boosted by improving consumer confidence.

A sharp fall of annual inflation in the coming few months is baked into the figures, from lower energy prices, higher sterling reducing import prices, and the unwinding of a distortion from supermarket loyalty card discounts. Falling headline inflation will reinforce the positive impact of rising real wages and encourage consumers to reverse their current build-up of precautionary savings.

However, this positive economic outlook removes pressure on the Bank of England to cut interest rates. Instead, it can wait for the current high pay rises to fall, likely in the second half of the year.

Mortgage rates, linked to five-year interest rates, have already fallen back and with high employment and rising real wages supporting demand, the housing market has seen a pickup in activity. We expect that house prices will rise from here.

This forecast turnround in the UK economy does not translate directly for UK equity markets, or indeed the Conservatives in the upcoming election. The international focus of the FTSE 100 dilutes the benefits of recovery in the UK, while its sectoral composition means that it is likely to lag gains from global equities. For the Conservatives, falling inflation and better growth will cut the opinion poll deficit, but is unlikely to be enough to change the outcome. It will provide a favourable economic wind for the next government.

Figure 3: GDP growth % quarter on quarter
GDP growth
Source: Bloomberg and Columbia Threadneedle Investments forecasts, as at 26 February 2024. Estimates and forecasts are provided for illustrative purposes only. They are not a guarantee of future performance and should not be relied upon for any investment decision. Estimates are based on assumptions and subject to change without notice.

European growth to recover slowly in 2024

It is easy to look at German manufacturing data and be too pessimistic about the outlook for the European economy. Manufacturing is a global soft spot, while weak German exports to China are another factor.

Instead, the wider figures show that European inflation is falling fast, real wages have started to recover from the energy crisis hit and that consumer confidence is following. That alone is sufficient to support modest growth. Interest rate cuts will also support recovery, though the ECB is keen to wait until it is clear that pay rises are trending down.

We think that sustained higher employment levels in Europe points to a shift of the economic equilibrium. With growth, inflation and interest rates set to trend above previous very low levels, that will limit the scope for interest rate cuts in Europe.

Figure 4: Eurozone real compensation per employee
Eurozone real compensation per employee
Source: Columbia Threadneedle and Societe Generale as at 14 January. Estimates and forecasts are provided for illustrative purposes only. They are not a guarantee of future performance and should not be relied upon for any investment decision. Estimates are based on assumptions and subject to change without notice. 

We are positive on asset markets, but the scale of returns is likely to be moderate.

For equities, we do not believe that expensive valuations, especially in the US market, preclude gains as the economy recovers, while inflation and interest rates fall. But it does cap forecast equity returns.

By contrast bond yields offer an attractive, real ‘risk-free’ return. However, the rising supply of government bonds from higher budget deficits, but also the unwinding of purchases by central banks, is likely to keep bonds looking cheap to attract buyers.

High interest rates and falling inflation means attractive cash returns will keep some investors on the sidelines. That will help underpin markets, especially when interest rates fall.

Figure 5: Total net supply of Euro government bonds (EGB)
total net supply of euro government bonds
Source: Columbia Threadneedle Investments and Societe generale as of 17 January 2024. EGB=European government bonds. PSPP=Public Sector Purchase Programme. PEPP=Pandemic Emergency
6 March 2024
Steven Bell
Steven Bell
Chief Economist, EMEA
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Interest rates, growth and financial markets

Risk Disclaimer

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients).

 

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act and relies on Class Order 03/1102 in marketing and providing financial services to Australian wholesale clients as defined in Section 761G of the Corporations Act 2001. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

 

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

 

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

 

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

 

In UK: Issued by Threadneedle Asset Management Limited. Registered in England and Wales, Registered No. 573204, Cannon Place, 78 Cannon Street, London EC4N 6AG, United Kingdom. Authorised and regulated in the UK by the Financial Conduct Authority.

 

In the EEA: Issued by Threadneedle Management Luxembourg S.A. Registered with the Registre de Commerce et des Societes (Luxembourg), Registered No. B 110242, 44, rue de la Vallée, L-2661 Luxembourg, Grand Duchy of Luxembourg.

 

In Switzerland: Issued by Threadneedle Portfolio Services AG, Registered address: Claridenstrasse 41, 8002 Zurich, Switzerland.

 

This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors’ with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

 

 

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Risk Disclaimer

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients).

 

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

 

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act and relies on Class Order 03/1102 in marketing and providing financial services to Australian wholesale clients as defined in Section 761G of the Corporations Act 2001. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

 

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

 

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

 

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

 

In UK: Issued by Threadneedle Asset Management Limited. Registered in England and Wales, Registered No. 573204, Cannon Place, 78 Cannon Street, London EC4N 6AG, United Kingdom. Authorised and regulated in the UK by the Financial Conduct Authority.

 

In the EEA: Issued by Threadneedle Management Luxembourg S.A. Registered with the Registre de Commerce et des Societes (Luxembourg), Registered No. B 110242, 44, rue de la Vallée, L-2661 Luxembourg, Grand Duchy of Luxembourg.

 

In Switzerland: Issued by Threadneedle Portfolio Services AG, Registered address: Claridenstrasse 41, 8002 Zurich, Switzerland.

 

This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors’ with information about Group products and services and is not for further distribution. For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

 

 

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