The Federal Reserve's unexpected substantial interest rate cut recently has boosted sentiment in European capital markets. On September 19th local time, major European stock indices rose across the board. The Eurozone's Stoxx 50 blue-chip index closed up by 2.24% for the day, and the pan-European Stoxx 600 index also performed strongly, closing at 521.67 points, approaching its historical high of 525.05 points set on August 30th. The German stock market's performance was particularly eye-catching; the Dax index opened sharply higher after the interest rate cut announcement and maintained an upward trend throughout the day, propelling the index to break the 19,000-point milestone for the first time in its history.
Historically, European stock markets have generally responded positively to interest rate cuts by the Federal Reserve. Investors typically view rate cuts as a favorable catalyst for assets like stocks, as lower borrowing costs can encourage corporate investment and expansion. Traditionally, rate cuts also benefit bonds and the real estate market, the latter potentially benefiting from increased demand for mortgages.
Of course, a key factor to consider is whether the rate cut is triggered by concerns that the U.S. economy may be heading into a recession. On this point, traders seem inclined to remain optimistic. Steven Bell, Chief Economist for Europe, the Middle East, and Africa at Columbia Threadneedle Investments, stated that lowering interest rates is beneficial for both the economy and the financial industry. He said, "We do not see a catalyst for a downturn, so we are still enjoying the process." Raphael, Head of Capital Markets Strategy at Tikehau Capital Management in Paris, France, said, "The risk of policy mistakes is always present, but we will only know later. Overall, the positive backdrop that drives European stock markets back to historical highs still exists."
Compared to the buoyant stock market, the reality of the Eurozone's macroeconomic situation appears much bleaker. On September 23rd, survey data released by S&P Global and Commerzbank showed that the Eurozone's manufacturing Purchasing Managers' Index (PMI) for September (44.8) was lower than the median forecast by market survey economists (45.6); the service sector PMI for the month (50.5) also declined, significantly below market expectations (52.4). As a result, the Eurozone's composite PMI (48.9) continued to slide, once again falling well below expectations (50.6), reaching a new low in eight months.
More alarmingly, economic activity in the Eurozone's private sector has contracted for the first time since March of this year. This sign intensifies concerns about the region's economic recovery prospects. Despite cooling inflation and rising wages, consumers remain cautious and unwilling to increase spending. Additionally, weak foreign demand has put greater pressure on European manufacturing, especially German factories. The plight faced by German automakers like Volkswagen is a microcosm of this issue. Commerzbank economist Cyrus de La Rubia said in a statement, "The Eurozone is heading towards stagnation." He specifically mentioned that the rapid decline in backlog and new orders indicates that economic activity will continue to weaken, suggesting that the Eurozone may face greater economic challenges in the coming months.
Analysts generally attribute the Eurozone's economic weakness mainly to poor performance by core countries such as Germany and France. Germany's manufacturing sector is facing multiple challenges, including weak global demand, increased overseas competition, and domestic structural issues. In September, Germany's composite PMI fell from 48.4 to 47.2, indicating an accelerated contraction in manufacturing and a near-stagnation in the service sector. As the largest economy in the Eurozone, Germany's sluggish performance has dragged down the recovery of the entire region.
Meanwhile, France's economic growth momentum has also noticeably slowed. Although the Paris Olympics briefly provided an economic boost, this rebound effect quickly faded, and service sector activity declined significantly. Overall, France's composite economic activity indicators show that after growth in August, the economy has once again fallen into contraction, with the service industry being severely affected and growth rates falling back.
The complex and severe geopolitical reality also fills the European decision-making layer with a sense of crisis. Two days after the Federal Reserve's rate cut, European Central Bank President Christine Lagarde pointed out in a speech at the headquarters of the International Monetary Fund: "Europe is facing the most severe pandemic since the 1920s, the most severe conflict in Europe since the 1940s, and the most severe energy shock since the 1970s." The combination of these disruptive factors, especially ongoing supply chain issues, has permanently changed the way the global economy operates.
Faced with intertwined internal and external difficulties, stimulating economic vitality through further rate cuts has become a hotly debated policy option among many market participants. Some analysts believe that with the Federal Reserve's rate cut now a done deal, the aggressive 50 basis point cut also leaves more room for other central banks to ease. Stefan Gerlach, Chief Economist at Swiss bank Julius Baer, said last week that although the European Central Bank has been opposed to the option of consecutive rate cuts, the Federal Reserve's substantial rate cut may prompt the European Central Bank to consider lowering rates again next month, marking the third rate cut since June.
However, there are also many who oppose the European Central Bank's "step-by-step" approach with the Federal Reserve. Dirk Schumacher, an economist at Natixis, said that unless the Federal Reserve's rate cut has an impact on the Eurozone's fundamental data, it would be absurd and unacceptable for the European Central Bank's Governing Council to follow suit with a rate cut in October simply because the Federal Reserve has made a rate cut decision.Stubborn inflation stickiness is a significant factor that constrains the decision-making of the European Central Bank (ECB). Currently, the inflation rate in the eurozone stands at 2.2%, but according to the ECB's forecast, this figure may slightly rise to 2.5% by the end of this year, and it will gradually decline to the target level of 2% only in the final weeks of 2025.
Faced with this situation, the "hawkish" faction among policymakers has expressed a cautious stance. They are concerned that the ECB's anti-inflation actions are not yet over, and there are still many uncertainties in the economy. Adjusting monetary policy too quickly could bring potential long-term inflation risks, especially when supply chain issues have not been fully resolved. Therefore, these officials recommend a steady and sustained reduction in interest rates, avoiding overly aggressive actions, while maintaining sufficient policy flexibility to ensure that inflation can be suppressed in the long term.