European market and fund review – will the ECB cut interest rates this summer?

The prospect of a recession loomed over most global economies last year. Inflation remained high, and interest rates elevated, pushing up costs for consumers and businesses alike.

Yet stock markets broadly remained resilient, including in Europe.

Looking forward to the rest of this year, investors are focused on when global central banks might cut interest rates, and the potential impact on stock and bond markets.

This article isn’t personal advice. If you're not sure if an investment is right for you, ask for financial advice. All investments fall and rise in value, so you could get back less than you invest. Past performance isn’t a guide to the future.

When will interest rates fall in Europe?

It looks like we’ve reached peak inflation and policymakers across the globe, including those at the European Central Bank (ECB), are now moving closer to cutting interest rates.

Until recently, global inflation had proved stickier than expected, leading markets to believe that rate cuts could be put on hold. But last week we saw Eurozone inflation ease to 2.4% in the 12 months to March.

The 2.4% was lower than economists had expected, but overall, inflation has gradually been falling closer to the ECB’s target of 2%. The bank recently lowered its inflation forecast for this year from 2.7% to 2.3% and is predicting it will reach its 2% target in 2025.

Against this backdrop, the ECB could cut rates as early as June. That said, the bank is waiting to gather more evidence and data over the coming months, and any rate cut will be based on what they see.

The ECB also reduced its Eurozone growth forecast for the year from 0.8% to 0.6%. While slowing growth can be a catalyst to cut rates, there are concerns that wage growth could keep inflation above the 2% target.

So, a rate cut in June isn’t guaranteed – even if rates are cut, the question then becomes how quickly the bank continues to cut rates from that point.

While the ECB makes decisions on the Eurozone as a whole, investors should remember it’s made up of a range of countries with different rates of growth and success.

Italy, for example, struggled following the 2010 European debt crisis, as debts mounted, and banks were on the brink of defaulting.

However, Italy’s economy has performed relatively well over the past couple of years, while the outlook for Germany – traditionally the poster child for European growth and stability – has deteriorated.

While Italy’s economy grew in the final quarter (the last three months) of 2023, Germany’s contracted. This difference could continue, as the Bank of Italy expects growth of 0.6% this year, compared with 0.4% as forecast by the Bundesbank (Germany’s central bank).

Each European country has its own rate of inflation and growth expectations. And that means investors should take a long-term view, with a balanced and diversified investment portfolio.

How have European stock markets performed?

European stock markets have generally performed well over the past year (in sterling terms, to the end of March 2024).

The broader European stock market, as measured by the MSCI Europe ex UK index, has grown 13.57%*. On the other hand, the broader global market, the MSCI AC World index, has grown 21.18%. As always though, past performance isn’t a guide to future returns.

The global stock market has benefited from its large allocation to the US, in particular large tech companies, which have performed exceptionally well over the past year and beaten most other markets. But stock market growth from Europe shouldn’t be dismissed – this is still an impressive annual return.

It's important to remember that different markets and sectors, like tech, will come in and out of favour.

Looking at countries individually, three markets led the growth in Europe – the Italian, Danish and Dutch markets, up 34.66%, 32.05% and 22.22%, respectively.

In Denmark, pharmaceutical company Novo Nordisk, which makes up two-thirds of its market, performed well thanks to the popularity of its diabetes drugs in the US.

Elsewhere, investors have been tempted back into the Italian market. This is off the back of stronger economic growth and attractive company share valuations, while banks have also helped as rising interest rates boosted profits.

In the Netherlands, ASML, a semiconductor manufacturer that now makes up almost half of the Dutch market, has performed strongly, partly as demand for semiconductors has stayed strong.

European smaller companies haven’t performed as well as larger companies over the year. The MSCI Europe ex UK Small Cap Index only grew by 6.73%.

Part of this is because smaller companies tend to rely more on their domestic economies for success. This has hurt during a year where sentiment towards Europe and its rate of growth has generally been lower.

Larger, more-established companies are more likely to make a greater portion of their profits internationally. That said, the average fund in the IA European Smaller Companies peer group returned 5.91% over the same time.

How have European Wealth Shortlist funds performed?

All European Wealth Shortlist funds have delivered a positive return over the past year, though the level of performance is mixed. We usually expect this. A range of managers with different strengths, styles and areas of focus will perform differently in different economic conditions.

Remember though, investing is for the long term and performance here is over a short timeframe.

Investing in funds isn't right for everyone. Investors should only invest if the fund's objectives are aligned with their own, and there's a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

For more details on each fund and its risks, including charges, see the links to their factsheets and key investor information.