Macro and Market Trends: UK grapples with sticky inflation as US and EU cut rates

US non-farm payrolls came in at 142,000 in August, versus 89,000. The unemployment rate was 4.2% in August versus 4.3% in July whilst average hourly earnings rose 0.4% in August, against a 0.2% gain in July.

July’s jobs report, published on 2 August, painted a bleak picture. Although unemployment had been ticking higher over the course of the year, the non-farm payrolls had generally been telling the opposite story, with jobs creation regularly providing positive surprises. 

That mixed messaging ended abruptly with last month’s data, when both unemployment and non-farm payrolls disappointed. In response, there was a bumper 50 basis points (bps) cut by the Federal Reserve (Fed) at their September meeting, causing a surge in stock market volatility.

The data doesn’t currently point at an impending recession. Employment is still growing in the US but at a slower pace than last year. Crucially, demand for workers is still larger than supply.

The European Central Bank (ECB) cut interest rates by 25bps at their September meeting, which had been anticipated by investors. This was their second rate cut this year and took their key deposit rate to 3.5%.

The ECB’s decision to cut interest rates comes amid concerns over sluggish growth. The most recent figures reveal that Eurozone GDP slowed and grew by only 0.2% over the second quarter, down from 0.3% for the preceding quarter.

Wage growth has been a focus for the ECB, and has slowed significantly in Germany, to 3.1% in the second quarter from 6.2% in the first. This gives the ECB room to act, but there are still areas of concern. Services inflation remains stubbornly high, currently at 4.2% on an annualised basis, due to rising hospitality prices and holiday costs.

Despite these concerns, another 25bps cut is expected by the end of the year. The ECB continue to indicate that their preferred approach is a gradual one, retaining flexibility to change course if required and will be data dependent.

Overall, the economic backdrop in the European Union continues to support further interest rate cuts, but any deterioration in global economic conditions or stickier inflation are risks to this view.

A lower cost of borrowing is good news for European businesses, who carry a higher proportion of floating rate debt than their US counterparts, so it should provide a relative boost to European equities.

The Federal Open Market Committee (FOMC), the group responsible for setting monetary policy at the Federal Reserve (Fed), voted to cut rates by 50bps to 5% at their September meeting.¹

There was little doubt that the Fed would cut interest rates, but whether they would go for a ‘regular’ size 25bps or the ‘large’ 50bps was the subject of much speculation.

The Fed made a bigger cut than many expected, however we continue to believe a ‘soft landing’ is the most likely outcome for the US economy. Further interest rate cuts will aid a rotation in the US stock markets away from the dominant mega-caps, who will earn less on their cash piles, and towards the unloved areas of the market such as small caps. These companies should benefit from cheaper borrowing costs due to a greater exposure to floating rate loans.

Coming hot on the heels of Federal Reserve’s sizeable 50bps cut, the BoE held their base rate at 5% at their meeting last month. This was consistent with expectations following the first 25bps cut this cycle in August.

Recent data in the UK was an unattractive combination of weaker than expected gross domestic product (GDP) growth and sticky inflation – with Core CPI (excluding energy, food, alcohol and tobacco) at 3.6% and services CPI at 5.6%. 

The BoE held interest rates to 5%. As per their guidance, we expect them to continue to emphasise their focus on the data but a 25bps cut in the November meeting is already being priced into markets.

If you have any questions about how this can impact your portfolio and investment decisions, contact your investment manager or financial planner today.