As European corporate treasurers and cash investors return to their desks after the summer holidays, they are facing a markedly different investment landscape compared to the first half of 2024. With inflation moderating, the BoE and ECB have shifted their focus towards safeguarding economic growth and have begun cutting rates. While markets have quickly priced in aggressive rate cuts, the frequency and pace of the central banks’ actions remain uncertain, creating a more challenging investment environment for EUR and GBP cash investors.

Are the ECB and BoE about to commence a concerted rate-cutting cycle? 

The ECB cut rates in June, but recent meeting minutes revealed a range of views and discomfort with pre-committing to further cuts. President Lagarde’s repeated emphasis on data dependency suggests that future policy decisions remain finely balanced. In the UK, the Monetary Policy Committee (MPC) was one meeting behind the ECB in initiating the first rate cut. The decision was made by the narrowest of margins, with Governor Bailey casting the deciding vote. With two committed hawks departing from the MPC, future decisions are even more uncertain. For both central banks, future decisions remain data dependent. We believe the ECB will continue cutting rates at alternate meetings into 2025, while the UK base rate will likely remain unchanged at the next MPC meeting in September, before cutting at alternate future meetings.

Will interest rates remain restrictive? 

Most Eurozone economies remain robust while the ECB’s own three-year CPI forecast indicates that inflation will continue to fall, albeit remaining slightly above 2%.  Meanwhile, recent UK economic data was better-than-expected, indicating an upturn in UK economic growth, although potential tax increases by the new Labour government could negatively impact growth and base effects suggest that inflation could rise back above the central bank's target rate by year-end.  This implies the ECB and BoE will proceed with caution rather than urgency in deciding the pace of future rate cuts, with any loosening of monetary policy viewed as precautionary to help achieve a soft landing.

What other policy tools does the ECB and BoE have at their disposal? 

By the end of 2024, all Targeted longer-term refinancing operations (TLTRO) tranches will be fully repaid by banks and short-term funding requirements will be met through the ECB’s regular refinancing operations. Additionally, the ECB is tapering Pandemic emergency purchase programme (PEPP) reinvestments by €7.5 billion per month starting in July 2024 and will cease all reinvestments from January 2025.  The BoE has been actively reducing its balance sheet, selling bonds from its portfolio and decreasing it from £875 billion to below £700 billion. Additionally, the BoE has expanded its Short-Term Repo facility, increasing lending to banks against high-quality collateral from £5 billion to over £35 billion over the past year.

How should Liquidity Investors navigate the remainder of 2024? 

We believe a balanced and laddered maturity approach is warranted to ensure a high level of liquidity while opportunistically locking in longer tenor yields when appropriate. Given the significant number of rate cuts priced in by the market compared with ECB and BoE’s guidance, investors should be flexible to avoid significant negative carry if they anticipate a different near-term path of policy rates.

Are there any external risks outside of the central banks’ control? 

The current geopolitical environment remains volatile, and US politics and Federal Reserve monetary policy via FX rates could impact the transmission of central bank policy decisions into the real economy.

Conclusion

In conclusion, as EUR and GBP cash investors navigate an evolving investment landscape, they should remain vigilant and adaptable. The uncertain pace of rate cuts by the ECB and BoE, coupled with external risks such as geopolitical volatility and US monetary policy, necessitates a flexible investment strategy. By adopting a balanced and laddered maturity approach, investors could maintain liquidity while capitalizing on longer-term yields. Staying informed and responsive to central bank actions and economic indicators will be crucial for successfully managing investments through the remainder of 2024 and beyond.

Source for all data is BoE, ECB and J.P. Morgan Asset Management, data as at 30 August 2024, unless otherwise stated.