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Interest rate setters in the US and the UK may have lowered rates recently, but investors now expect short-term rates to be nearly a full percentage point higher in a year’s time than they did three months ago. These views are reflected by movements in the 3-month Sonia (UK) and 30-day Fed funds (US) futures in the chart above, and contrast with the expected outlook for the 3-month Euro STR (EU), where rate expectations have been falling. A range of factors might explain this divergence, including the outlook for fiscal policy. In the UK, the Budget detailed a net expansionary fiscal policy, with an effective relaxation of fiscal rules and significant increase in government investment. Across the pond, Donald Trump proposes fiscal loosening through corporate tax cuts. By contrast, the EU recently reinforced its commitment to existing fiscal rules, therefore signalling a more conservative fiscal policy than its peers. This divergence could lead to a divergence in the inflation outlook, and hence the outlook for monetary policy. As a result, investors seem to think that the ECB may be better placed to continue cutting interest rates than the Fed or the Bank of England.
The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.
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