European shares rally, eyeing ECB rate move

European stocks rebounded and government bond yields fell on Monday as investors anticipated an interest rate cut from the European Central Bank (ECB). Meanwhile, upcoming U.S. jobs data kept inflation concerns in focus.

The pan-European STOXX index gained 0.4%, and U.S. stock futures also rose.

In bond markets, the U.S. 10-year Treasury yield dropped by 5 basis points to 4.47%, and German yields, which hit six-month highs last week, also declined.

Attention was primarily on the ECB, expected to reduce rates by a quarter point to 3.75% on Thursday. However, a higher-than-expected eurozone inflation reading last week weakened the case for rapid rate cuts. Markets now anticipate fewer than 60 basis points of easing, implying two 25-basis point cuts and less than a 50% chance of a third cut.

“There’s a relatively positive risk tone to start the week, which seems like a continuation of the positive momentum seen on Friday, albeit somewhat surprising given the bumper calendar of event risk coming up,” said Michael Brown, a strategist at broker Pepperstone in London.

Data released on Monday showed China’s factory activity grew at the fastest pace in nearly two years in May, extending market optimism following U.S. inflation data on Friday, which showed the Federal Reserve’s preferred measure of inflation held steady in April.

“The ECB decision is perhaps the most important event to watch, particularly after last week’s inflation data, which raises the hawkish risk that there is only one more cut this year after a 25bp reduction on Thursday,” Brown added.

Markets also predict around an 80% chance the Bank of Canada will cut rates at its Wednesday meeting, with around 60 basis points of easing expected this year. Analysts hope for even deeper cuts.

Investors are less dovish on the Federal Reserve, seeing little chance of a rate move until September. However, the odds of a move then increased following Friday’s inflation data. They price in less than a 60% chance of a second cut by December.

This week’s data, including key manufacturing surveys on Monday, services on Wednesday, and the May payrolls report on Friday, could shift the outlook. The unemployment rate is expected to hold at 3.9%, with 190,000 net new jobs forecasted.

In Europe, focus was also on Standard & Poor’s downgrade of France’s credit rating, but the country’s bonds showed little reaction.

ASIAN STRENGTH

Currency markets saw the U.S. dollar start June steadily, flat against a basket of peers after its first monthly decline of 2024 in May. The euro was down 0.1% against the dollar at $1.0841.

The yen, this year’s worst-performing G10 currency due to low Bank of Japan interest rates, gained 0.3% against the dollar to 156.83, after hitting a four-week low of 157.715 last week.

Emerging markets were in focus following elections in India and Mexico. India’s rupee strengthened, and its stock market rose to a record high, buoyed by expectations of sustained economic growth as Prime Minister Narendra Modi looked set for a third term. Conversely, the Mexican peso fell 3% as markets feared that Claudia Sheinbaum’s landslide victory could lead to constitutional changes.

Earlier, Asian stocks rose on strong Chinese data, as well as positive reports from Japan and South Korea.

Gold increased by 0.1% to $2,330 an ounce, marking a four-month rally, helped by buying from central banks and China.

European natural gas prices surged over 8% to their highest this year, exceeding 37 euros/MWh due to an outage in Norway, Europe’s largest gas supplier since 2022, which sharply reduced exports on Monday.

Oil prices fluctuated after OPEC+ agreed on Sunday to extend most of its oil output cuts into 2025, though some cuts will start to be phased out from October 2024. Brent crude was up 0.2% at $81.24 a barrel, while U.S. crude rose 0.1% to $77.04 per barrel.

($1 = 157.1900 yen)