Will we see interest rate cuts in Q1?

If, when, and where the markets could see interest rate cuts in 2024 has dominated the last few months of industry chatter – but what are the figures looking like?

The European Central Bank in Frankfurt - will they cut rates early in 2024?

The prospect of rate cuts in the world’s major economies has been a talking point since moments after the various central banks began raising them to combat the escalating rate of inflation at the early part of the post-Covid-19 reopening.

“The most aggressive increase in interest rates in more than four decades helped quell inflation in 2023 and has opened the door to rate cuts,” said Aviva Investors in its House Views 2024 (Q1) Insights paper.

The major central banks once held rates during 2023 at 5-5.25% in the US, 5.25% at the Bank of England (BoE), and 4% for the eurozone’s European Central Bank.

“With headline rates in major economies still uncomfortably high, the inflation battle has not yet been completely won. However, recent data suggests inflation may fall back to central bank targets quicker than previously anticipated,” Aviva said.

US inflation has been more controlled in the last quarter of 2023, and many expected this to mean it will lead to at least one cut, if not several, in 2024. This was due to a variety of reasons. According to nowcast data from the Cleveland Federal Reserve, said Forbes last month, “inflation as measured by headline CPI is estimated to rise 0.3% month-on-month for December. A similar monthly increase of 0.33% is expected for core CPI (which removes changes in food and energy prices).”

This is a definite climb down from the pandemic-era peak of 9.1% in June 2022 and was taken as proof that the battle had been won.

Last year, most thought the US would see receding interest rates for the election year, but the US Federal Reserve (Fed) had made few moves by the end of 2023. “Barring any new 'risk premium' event in the energy sector, we'd share the view that the steady rate of disinflation in the US will continue through 2024, a continuation of the steady progress made in this area throughout 2023,” said Joe Tuckey, Argentex’s Head of FX Analysis in December.

“Where economic growth is already weak – as in the euro zone and UK – a return to 2% inflation could open the door to earlier and deeper rate cuts."

Elsewhere, CCLA Investments said in its December market update that the UK and eurozone’s central banks were at pains to avoid speculation about the timing and pace of rate reductions, though this did not prevent markets from pricing in easier monetary policy conditions well before the end of 2024.

If inflation fell, said Aviva, it would “enable central banks to start cutting rates”.

“Where economic growth is already weak – as in the euro zone and UK – a return to two per cent inflation could open the door to earlier and deeper rate cuts,” they said.

Eurozone, the wider EU, and UK growth has been sluggish. The OECD forecasted that the UK GDP would grow by 0.5% in 2023, up from 0.3% in its previous forecast – and by 0.7% in 2024, down from 0.8%.

Whereas the US economy grew by a healthy 5.2% in the third quarter, according to the Commerce Department in November, with the same level predicted for Q4 with consumers splurging on Christmas celebrations.

Overall, the OECD said that global growth had been stronger than expected in 2023 but that it would remain modest in 2024 and 2025.

So, will the US be the first to cut?

“The accelerating decline in inflation in the US and globally has made it likely that the Fed's rate cuts are likely to materialise before mid-2024,” said Ladislao Larraín, Chief Executive Officer at LarrainVial Asset Management in a Group of Boutique Asset Managers (GBAM) report.

“The risk is that central banks fall behind the curve in cutting rates,
at least initially."

CCLA Investments also said in its December update that “comments from Jay Powell, chair of the US Federal Reserve, fuelled market expectations that rates would begin to fall within the next six months or so”.

Aviva Investors was also of this opinion, with expectations for cuts. It did add, however, that upcoming cuts would be more limited. “In the United States, where inflation has fallen back despite growth being above potential, we expect rate cuts to be more limited in 2024,” said Aviva.

“Should recessions materialise, rates might be cut much more aggressively,” they added. “The risk is that central banks fall behind the curve in cutting rates, at least initially. In an alternative risk scenario, if inflation stays stubbornly high, this could prevent or delay rate cuts.”

The US media is already hotly reporting on the matter as a key factor in the 2024 election, but this is unlikely to affect the Fed’s actual decision.

What about in the UK?

The UK’s economic outlook remains patchier for 2024 with low growth expected.

"The fall in [the UK’s] headline inflation to 3.9% marks a dramatic and unexpected fall in UK inflation,” said Nicholas Hyett, Investment Analyst, Wealth Club in December. “While we're still seeing prices rise faster than the US and Europe, the UK is no longer the outlier it once was.”

The UK also has a general election this year and economic policy will be widely debated there too.

“The fall in inflation has been driven largely by lower oil & gas and food prices, with core inflation still high at 5.1%,” said Hyett on where the economy is heading. “Commodity prices aren't something governments or even central banks have much control over – and until core inflation (reflecting things like domestic pay rises) is back closer to target we suspect the BoE will remain cautious on interest rates.”

In December, the BoE brushed aside chatter of a rate cut with a consensus that it was too soon in the economic recovery to risk it.

"I suspect interest rates [may] remain where they are until wage growth comes down and the BoE can see that it is approaching its 2% target."

In Q3 last year, Sir Howard Davies, Chairman, NatWest, told Insurance Investor Live | Europe in his opening keynote that “The BoE monetary policy committee (MPC) may still have more tightening to do and although the inflation figure in September [2023] was better than expected, they are still floating well free of the 2% target.”

Davies added that once wage growth was under control there could be more movement, but he was still pessimistic. “My hunch is that there will be a little bit more tightening to come but that rates are quite close to their peak,” he said. “What I can’t see is an early reduction until the BoE is convinced that wage growth is under control. In the new jargon, I am a Table Mountain guy and not a Matterhorn man. In other words, I suspect that we may see interest rates remain where they are for a while until wage growth comes down and the BoE can see that it is approaching its 2% target.”

What does this mean for investment teams at insurers?

The good news is that heightened rates will see increased returns on some portfolios as that money feeds through; however, higher rates can also be a drag on liquidity.

2024 is likely to see a repeat of 2023 where investment returns propped up profits that were subdued on the underwriting side by sluggish economic growth and natural catastrophe losses, which continued to be elevated.

This means any cut will have both positive and negative effects on insurer’s portfolios as higher rates reduce the present value of assets with fixed payments, including bonds, and other fixed-rate securities.

However, it’ll be economic growth to watch for – Europe teeters on recession while the US grows – and all signs do point to a rash of cuts in early to mid-2024.