European stocks poised for surge as ECB meeting nears

A historic European Central Bank meeting this week may be the catalyst that drives regional equities to new peaks.

The ECB is expected on Thursday to start an interest-rate cutting cycle before the Federal Reserve for the first time ever, as inflation in the euro area cools faster than in the US. There’s also an improving outlook for corporate earnings, with Europe’s economic growth remaining resilient.

That’s leading asset managers and market strategists to say there’s room for the benchmark Stoxx Europe 600 Index to build on a record-hitting rally so far this year, even if the timing of the Fed’s rate cuts remains uncertain.

“All in all, it’s a pretty good combination for stocks,” said Lilia Peytavin, a portfolio strategist at Goldman Sachs Group Inc. in Paris. “What’s crucial on Thursday is the new growth and inflation outlook of the ECB. We’re expecting growth to rebound in the euro zone in the coming quarters, so that should be good” for so-called cyclical stocks.

History shows easing monetary policy bodes well for equities. Since the 1980s, European stocks have risen 2% in the month following a rate cut from the Fed, roughly twice the performance of equities in any given month, according to an analysis by Goldman Sachs. The rally over 12 months tends to be much stronger when the cuts are accompanied by a robust economy, the data showed.

Of course, the 8% gains this year already reflect some optimism. The euro zone has exited recession, with its four top economies driving speedier growth than expected. At the same time, traders have now fully priced in at least two rate cuts from the ECB in 2024.

While that limits the odds of a “big bounce” if the central bank does cut rates on Thursday, “the move won’t be irrelevant,” said Luca Paolini, chief strategist at Pictet Asset Management. “Maybe it’s priced in but there’s a psychological impact that cannot be disregarded considering fundamentals are slowly moving in the right direction.”

There’s even more good news over the medium-term outlook. Citigroup Inc. strategists said there’s a chance rates will eventually settle at around 2% — lower than the current level but higher than the zero-rate era of the past decade. That may help investors choosing Europe, since the region’s cyclical stocks “were much more likely to outperform the US in the pre-global financial crisis world,” strategist Beata Manthey wrote in a note.

The relief is most likely to be evident in debt-laden sectors such as real estate. High borrowing costs and concerns about refinancing have hit property valuations, making the sector among the biggest laggards in Europe this year. Automakers are also set to win, partly as lower rates make car financing more affordable.

Banks, on the other hand, are likely to lose out after being the top-performing Stoxx 600 sector so far in 2024. JPMorgan Chase & Co. strategists said they’re cautious on lenders as the “phase of earnings outperformance might be ending.”

One potential source of overall risk is stickier-than-expected inflation, which could derail the outlook for further rate cuts. Most economists still expect quarterly reductions following this week’s initial move, but some reckon that elevated price pressures and rapid wage growth will constrain easing — especially if economic resilience continues.

“As things stand, we believe an ECB cut this week may soon be viewed as a policy mistake,” said Gabriele Foa, a portfolio manager at Algebris Investments.

Other market participants are less concerned. Oddo BHF SCA strategist Thomas Zlowodzki said a combination of the first rate cut, easing political uncertainty following European Parliament elections this weekend and a rebound in economic growth are all reasons to remain positive on regional stocks.

“All these stars aligning makes us think that mid-June might be the right moment to overweight Europe,” Zlowodzki said.