Investors lowered their expectations for a rapid interest rate cut in the eurozone and the UK, and also the US.
The global sell-off occurred after European Central Bankpresident Christine Lagarde indicated that borrowing rates would fall in the summer and not spring. The sell-off also came after the first increase in UK inflation for 10 months.
Lagarde stated that market expectations of a rate cut by the ECB this spring “does not help” in fighting inflation.
Stoxx Europe 600, the region’s stock index, closed down 1.2 percent on its worst day since October. London’s FTSE 100 closed down 1.5%, its weakest session since the middle of August.
Losses spread to the US, as the strong retail sales data cast doubts on the prospects of an early rate cut by the Federal Reserve. The data revealed that consumer spending in December increased at the fastest rate since September.
S&P 500, Nasdaq Composite and Dow Jones both dropped 0.6 percent in New York. It was their worst day for two weeks.
Charles Hepworth said that the hopes of early rate cuts from central banks around the world were overly optimistic.
Lagarde was asked if she agreed that a rate reduction is expected in the summer by her fellow ECB governing board members. She replied: “I’d say it’s likely, but I need to be cautious.”
Lagarde said to Bloomberg TV that at the World Economic Forum, the ECB will have all the data it needs on wage pressures “late spring”. These data are needed before a decision is made on lowering borrowing costs.
The bond markets also saw a drop in prices. UK 2-year bond yields rose 0.22 percentage points, inversely correlated with the price, to 4.35 percent. The US yield on two-year bonds rose by 0.13 percentage points, to 4.35 percent.
The price of government bonds has already fallen after Fed board member Christopher Waller warned that the US central banks should not also rush to reduce rates.
The unexpected increase in inflation from 4% to 4% caused traders to reduce their bets for rate cuts by the Bank of England.
The December figure is the first increase in UK inflation since Feb 2023.
Matthew Landon of JPMorgan Private Bank’s global market strategist warned that the data could delay the BoE from making a pivot in policy: “Markets might be overly optimistic about the number of cuts [the BoE] will manage this year.”
Rate-sensitive real estate companies were among the worst performing stocks as European stocks responded to the prospect that interest rates would be cut later than expected. The CAC 40 in France fell by 1.1 percent, and the Dax in Germany dropped by 0.8 percent.
Lagarde, speaking a day ahead of the ECB’s quiet period that will begin on January 25 before its next meeting, said she is increasingly confident the eurozone’s inflation will sustainably fall to the central banks’ 2 per cent target over the medium term. The annual price growth rate in the EU has dropped from 10.6 percent in October 2022, to just 2.9 percent last month.
The ECB President warned that inflation in the labour intensive services sector was still too high — at 4% in December — as well as the risk of wage growth. Last year, wages in the eurozone increased by 5.2 percent per employee, maintaining price pressures.
She said that “short of another major event, we have reached the peak” for interest rates. “But we must remain restrictive as long as it is necessary” in order to keep inflation down. The risk is that we would go too quickly [on rate reductions] and then have to do more [rate hikes].
Klaas Knot – head of the Dutch central banks and a member on the ECB’s rate-setting governing board – echoed her comments, telling CNBC Wednesday that “the more easing we have already received from the markets, the less we are likely to cut rates.