While UK and US interest rates look set to remain on hold for the foreseeable future, the European C...
While UK and US interest rates look set to remain on hold for the foreseeable future, the European Central Bank (ECB) is expected to cut rates in the next two months.
This month's 50 basis point rate cut by the Federal Reserve was not replicated by either the Bank of England Monetary Policy Committee or the European Central Bank and surprised many observers who had expected a 25 basis point cut in Europe.
Indeed the UK's Monetary Policy Committee has indicated inflation is likely to remain above its 2.5% target for the majority of 2003, reducing the likelihood of further rate cuts.
The ECB meanwhile maintained its 3.25% rate following a mild upswing in the euro's fortunes. The true motivation behind the ECB's lack of action has been questioned by a number of observers, however, and Simon Rubinsohn, chief economist at Gerrard, is sceptical about whether the ECB's present strategy is sustainable.
'The move highlights ECB's determination to demonstrate its independence from the financial markets,' says Rubinsohn.
'That said, with the growth prospects for the eurozone lacklustre at best, as indicated last week by the European Commission, it is hard to believe that any cut in rates in December will not be followed by further easing in the New Year.'
Fraser Chalmers, an investment director at Standard Life Investments, has been positioning his portfolio in anticipation of an ECB rate cut. Chalmers is favouring economically sensitive stocks, such as financials, engineering, capital goods and basic industries stocks and has moved underweight defensives.
Chalmers says: 'The ECB moved its bias from having had its finger on the raise button as concerns over rising inflation were overtaken by the threat of stunted economic growth.'
Growth predictions have also been pared back in the US. According to IBES, 2003 consensus earnings growth forecasts for S&P 500 stocks have fallen from 9% back in September to 7% at the start of November. This compares with 14% in the first quarter.
Rubinsohn says FTSE 100 earnings growth forecasts are even more gloomy, with consensus now predicting negative earnings growth next year.
'The key issue here is whether companies have eliminated sufficient fat to sustain the recovery in profit margins. On both previous occasions over the past 23 years that the corporate sector endured a recession, significantly heavier redundancy programmes were needed to create the conditions for a material improvement in its wellbeing,' Rubinsohn says.
'It might be different this time but we are not yet convinced. If companies in both the US and UK are disappointed in their profit expectations and forced to turn their attention back to cost-cutting, it may turn out to be rather prolonged.'
Indeed, private sector employment data reveals redundancies were up to five times as severe in the early 1980s and the early 1990s, although Rubinsohn notes more workers have moved across to the public sector than in previous downturns.
However, he adds, the group believes the risks associated with equities still remain skewed toward the downside and it is premature to rule out further rate cuts in either the US or UK next year.
Eurozone rate cut likely in December.
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