Following a surprise rate cut by the Swiss National Bank (SNB, Financial), which lowered its key rate to 1.5% from 1.75%, markets across Europe have seen a significant shift. This unexpected move has led to a decrease in government borrowing costs and propelled the continent's Stoxx 600 share index to a new record high. However, analysts advise caution, highlighting that other central banks, such as the U.S. Federal Reserve, may not be as quick to reduce borrowing costs amid ongoing inflation concerns.
The Swiss decision has been seen as a pivotal moment by investors, with strong expectations now set for rate cuts in June by both the European Central Bank (ECB, Financial) and the Bank of England (BoE). Despite the potential risks of inflationary currency weakness in a strong-dollar environment, some analysts believe these central banks might proceed with rate cuts before the Fed does. Money markets have adjusted their expectations accordingly, pricing in a 90% chance of an ECB rate cut by June and a roughly 70% chance for the BoE.
Switzerland's unique position, with its headline inflation rate at 1.2% in February, within the SNB's target range of 0-2%, sets it apart from the UK and the eurozone. The SNB's early move to ease was driven by concerns over the deflationary impact of a strong Swiss franc. Following the rate cut, the Swiss franc fell to a nine-month low against the euro and dropped over 0.5% against the dollar.
In the UK, following the BoE's meeting, the yield on the two-year gilt saw a significant drop, marking its best performance in nearly a month. Similarly, Germany's equivalent bond yield decreased, highlighting the positive impact of anticipated rate cuts on bonds.
Despite the excitement, some experts, like Salman Ahmed from Fidelity International, warn that the Fed might delay easing borrowing costs. The ECB and the BoE face the risk of currency weakness and further inflation by moving ahead of the Fed. With UK inflation still above the BoE's target, the path forward remains challenging.
Investors are showing increased interest in UK and European government debt, anticipating that rates will eventually fall regardless of the exact timing of the first cut. Some, like Joost van Leenders from Van Lanschot Kempen, are already adjusting their portfolios to benefit from the expected decrease in yields.
