Midweek market update: the euro area’s first rate cut since 2019?

The market awaits tomorrow's European Central Bank meeting to see whether Europe beats the UK and the US to the first interest rate cut.

While bets on the cut have pulled back a touch, the majority still expect the ECB to reduce the benchmark rate from 4.5% to 4.25%.

This will mark the first cut to borrowing costs for the euro area since September 2019.

It will mark the official end to the record fast-hiking cycle that began after the Covid-19 pandemic as inflation soared.But investors’ attention looks like it has already moved on to what will happen after this June cut by the Frankfurt institution.

“Judging by the commentary from officials, there is no questioning of the wisdom of cutting rates on 6 June,” said Mark Wall, ECB watcher with Deutsche Bank.

“Even with the upside surprise on May HICP [harmonised index of consumer prices], the ECB can argue a cut is consistent with its reaction function. The question is, what comes after June?”

Euro area inflation for May came in slightly higher than expected with headline inflation at 2.6% and the print for core at 2.9%. On top of that, negotiated wage growth, a figure closely watched by the ECB, did reaccelerate in the first quarter to 4.7% after hitting 4.5% in in the fourth quarter of 2023.

Gilt yields have also pulled back toward their lowest levels of the day, while the pound is climbing against the US dollar.

When other central banks begin cutting rates, it doesn’t necessarily impact the Bank of England directly, however, it does help smooth the path to its own rate reductions when it decides to implement them.

On the back of this expectation, stocks were up a touch on Wednesday helped by weaker-than-expected US jobs data. This slightly increased expectations of a rate cut by the Federal Reserve later this year.

The latest S&P Global UK services PMI business activity index came in at 52.9, the seventh successive month it has been above the neutral 50.0 level. A figure above 50.0 indicates growth while one below it suggests contraction.

However, May’s reading was down on April’s 11-month high of 55.0.

Respondents attributed May’s output growth to stronger sales, with new business volumes rising again during the month.

There was also a slight pick-up in both job growth and business confidence, while input cost inflation fell to its weakest sinceFebruary 2021. Input costs jumped in April after the increase in the national living wage pushed up labour costs.

New orders fell back slightly from the 11-month high seen in April, however. Respondents noted there had been a softer rise in demand, particularly from overseas customers.

The S&P Global UK composite PMI, a weighted average of comparable services and manufacturing indices, eased to 53.0 from April’s one-year high of 54.1.

Joe Hayes, principal economist at S&P Global Market Intelligence, said: "Taken in tandem, the PMIs imply GDP growth of around 0.3% so far in the second quarter.

"The survey shows prices for UK services rising at the slowest pace for over three years; that’s now three months on the trot that selling price inflation in the sector has eased. This will be very encouraging to the Monetary Policy Committee."

In the US we are constantly hearing about ‘goldilocks’ numbers but it looks like it’s the UK’s time. The economy is showing growth, manufacturing is increasing, services costs and inflation are coming down, what’s not to like?

‍

In equities

‍

In equity markets Haleon and Taylor Wimpey both rallied after Berenberg changed their status to  ‘buy’.

Pearson got a lift after Citi opened a 90-day "positive catalyst watch" on shares of the education publisher, pointing to an attractive risk/reward.

Paragon Banking jumped as the specialist lender more than doubled interim profit and said it would extend its share buyback by up to £50m as customer demand returned.

WH Smith rallied as the retailer said it remains on track to hit full-year forecasts despite a slowdown in sales growth in third quarter, as strong growth in the travel division was tempered by falling sales on the high street.

On the downside, B&M European Value Retail fell sharply despite saying that annual operating profits and sales grew in the double digits, helped by the opening of 78 gross new stores across the group, with earnings at the top end of guidance.

British Gas owner Centrica was in the red despite saying that current year trading was in line with expectations against the backdrop of a more "normalised" environment.

Ninety One slumped as it posted a drop in full-year assets under management and cut its dividend as it said business conditions remained "challenging".

Workspace lost ground as it reported strong rental income growth in the year to 31 March, but said losses widened substantially due to falling property valuations.

In the US equities remained higher and bonds fell after a report showed the US services sector expanded by the most in nine months, powered by the largest monthly gain in a measure of business activity since 2021. Earlier Wednesday, a private payrolls reading highlighted that hiring at US companies grew at the slowest pace since the start of the year.

Traders are now gearing up for Friday’s monthly payrolls report, which is expected to show the US added 185,000 jobs in May while the unemployment rate held steady.

With the Fed widely expected to stay on hold next week, the focus of the meeting will be the new Summary of Economic Projections.Back in March, Fed officials maintained their outlook for three rate cuts in 2024.

“The ‘dots’ are likely to cluster around one or two interest rate cuts this year,” said Stephen Brown at Capital Economics. “Nevertheless, as inflation falls a bit faster than officials expect and GDP growth disappoints, our base case remains that the Fed will cut in September.”

‍

In oil

‍

Oil hovered near a four-month low as an industry estimate for higher US inventories added to bearish sentiment, compounded by OPEC+’s plan to boost supply.

West Texas Intermediate was little changed near $74 a barrel ahead of the US Energy Information Administration’s weekly stockpile report. WTI has posted five straight days of losses, sitting in oversold territory after Sunday’s OPEC+ meeting.

Bearish supply forecasts are weighing on the market.The American Petroleum Institute on Tuesday reported US inventories expanded by 4.1 million barrels last week. Crude stockpiles increased at the storage hub at Cushing, Oklahoma, where the US benchmark is priced, according to API.

Oil has tumbled around 5% this week following a decision by OPEC+ on Sunday to start unwinding supply cuts in the fourth quarter, despite concerns about demand and higher output from outside of the group.

Keeping the price of oil contained will help the inflation fight and should fit nicely into the current narrative at the central banks.

Thursday and Friday are both important days ahead with the ECB rate meeting (first potential cut) and the US non-farm jobs report. A lot could still happen, but it’s been a relatively steady week so far.

‍

‍