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As the Federal Reserve Bank began its rate cutting cycle last week, executing a significant cut of 50 basis points (bps), the European Central Bank (ECB) elected to continue on its trajectory with another 25-bp rate cut.
While US data in recent weeks has reflected a resilient labour market and bolstered support for a soft landing, euro area data has not been as strong. Euro flash purchasing managers indices (PMIs) for September have raised fears that the economy may not be as resilient as investors had previously thought. Notably, the composite PMI for the euro area (the weighted average of the Manufacturing and Service sector indices) was back in contractionary territory for the first time in seven months while the euro PMI also saw the composite employment index fall to its lowest since early 2021, led by a decline in Germany.
As the German economy continues to struggle and the 10-year bund yield has fallen back during the month of September, the Franco-German spread has also widened. This means that the yield differential between the two markets has increased, as you can see from the below graph. At 78bps, the spread is now at its highest level since the post French snap-election divergence late this summer. With political and fiscal uncertainty remaining in France, we can see that yields are now again above year-to-date averages.
As the ECB’s October monetary policy meeting approaches, there are mounting expectations that the ECB might accelerate the trajectory of its rate cuts from the quarterly pace it has delivered so far, and instead start cutting at every meeting. Alternatively, the ECB could follow in the footsteps of the Fed and deliver a 50bps cut if deemed necessary.
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