Overview
This week’s Chart Room puts the spotlight on Germany, and two data points that show why the European Central Bank is under increasing pressure to cut interest rates sooner rather than later.
The first is inflation. Germany’s consumer price growth sank to its lowest rate in nearly three years in February, just above the ECB’s Eurozone-wide target, and it is expected to fall further in the months to come. The Eurozone’s harmonised index of consumer prices, for which the ECB has a 2 per cent annual inflation target, has also fallen substantially from its 2022 peak, hitting 2.6 per cent in February.
Second up are Germany’s purchasing managers’ indices. There are several different sentiment surveys tracking Europe’s biggest economy but the composite PMI is now one of the most watched. Before the pandemic hit, the PMI had a long record of bubbling along above 50 points - the dividing line that separates growth from contraction. It has now had sub-50 readings every month since July last year, implying the sectors it covers are contracting quickly. The flash PMI for April was 47.4.
There is no longer much of a dilemma here. Falling inflation means the rationale behind the ECB holding rates higher has all but disappeared: the economy is struggling and needs the support of lower borrowing costs. We should not be surprised if the ECB cuts rates before the Federal Reserve does, the bond market has already pulled forward expectations of rate cuts in the Eurozone while pushing them back for the US.
This will support the dollar over the euro in the months to come. There are also implications for German Bunds, which have outperformed US Treasuries since the start of March. Inflation in the US is sticky and looks to be re-accelerating. Consumer sentiment and the labour market appear to be resilient, with economists forecasting significantly higher growth for the US than Europe for 2024[1]. All of which should support US Treasury yields or push them higher.
Japan’s central bank meanwhile is going in the opposite direction to the ECB. The latter’s monetary policy meeting later this week follows the Bank of Japan’s decision last month to end its policy of negative interest rates and yield curve control. Against this backdrop we favour Bunds over Japanese government bonds.
Whatever decisions and remarks come out of this week’s ECB meeting and press conference, one conclusion is clear: weak growth and falling inflation dynamics support lower Bund yields at a time when the picture is much less clear for other major government bonds.
[1] Based on forecasts published by Consensus Economics.
