Slow and Steady Central Banks Brace for Tariff Impacts

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Eurozone Market Update

Donald Trump’s U.S. election victory saw markets pricing in potential adverse effects on European growth due to the prospect of new tariffs, increasing expectations for an accelerated pace of ECB rate cuts. ECB officials, including Vice President Luis de Guindos, stressed a data-driven approach but flagged inflation risks below the 2% target. Eurozone inflation fell to 2.4% in November versus expectations of 2.6%, strengthening the case for monetary easing. ECB Governing Council member François Villeroy de Galhau suggested flexibility on the size of potential cuts, leaving options open for December. The Eurozone Composite Purchasing Managers’ Index (PMI) dropped to 48.1, its lowest level since January, with significant declines in services and manufacturing across key economies. This data fuelled market speculation for a 50 bps cut, though we anticipate a more cautious 25 bps move, reflecting the ECB’s measured stance.

_{Source: Bloomberg, data as of 29 November 2024}

UK Market Update

The BoE reduced its policy rate by 25 bps in November to 4.75%, citing inflation progress, which was below 2% at the time. Governor Andrew Bailey cautioned against rapid cuts, a shift from his October comments that suggested a “more aggressive” approach to rate cuts. The Bank’s latest projections incorporating the Autumn Budget have inflation remaining above target until mid-2027, with 2025 and 2026 forecasts revised up to 2.7% and 2.2%, respectively. The BoE is expected to cut rates gradually, likely skipping December and moving to a quarterly cadence. October inflation surprised to the upside, with headline CPI at 2.3%, core at 3.3% and services at 5.0%. The BoE projects the bank rate will fall to 3.75% by late 2025, though markets expect slightly over 4%. We recognise the market’s rationale but maintain our forecast of a 3.75% terminal rate, acknowledging upside risks.

_{Source: Bloomberg, data as of 29 November 2024}

US Market Update

The Fed unanimously lowered the federal funds rate by 25 bps to 4.5-4.75%, a widely expected move following recent economic data and commentary since the September meeting. Future policy decisions will be data-dependent and evaluated on a meeting-by-meeting basis. November also saw Donald Trump elected as the 47th U.S. President, the first Republican to win the popular vote since 2004, as Republicans also took control of both Houses of Congress. Trump took to social media to declare that one of his first executive orders would be a 25% tariff on all products from Mexico and Canada and an additional 10% tariff on products from China. Markets reacted swiftly, with the Canadian dollar falling 0.86% to a four-and-a-half-year low and the Mexican peso dropping 1.20% against the U.S. dollar.

_{Source: Bloomberg, data as of 29 November 2024}

Looking Ahead

Looking forward to 2025, we anticipate diverging central bank policies. In the U.S., three likely scenarios exist: a soft landing, reflation, or supply restraint. The soft landing, our base case, assumes slower growth, easing inflation and gradual Fed rate cuts. The reflation and supply restraint scenarios assume that the incoming administration’s policy initiatives temporarily derail the disinflationary process, which would pause the Fed’s rate-cutting cycle. Europe’s outlook faces downside risks from domestic and external factors. Soft growth and inflation will likely allow the ECB to continue lowering rates cautiously. However, given the downside risks, we cannot rule out a more aggressive pace of rate cuts below our neutral estimate of around 2%. In the U.K., inflation remains the primary concern. Recent fiscal policies add pressure, supporting the BoE’s cautious, quarterly pace of easing. The BoE is expected to reach a terminal rate near 4%, with risks to the upside.

Chart of the Month

_{Source: Bloomberg as of 29 November 2024}

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