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June 10, 2024

European Central Bank cuts rates – Has summer finally arrived?

In a year of global elections, the UK results are now in. The Conservative Party suffered a dramatic defeat after 14 years in power, which was dominated by the Brexit vote and its aftermath, with five different prime ministers running the country during this period. The Conservatives lost 250 seats, a setback of historic proportions, and Labour now has a parliamentary majority of 172 seats, having won 411 out of the 650 total.

Key challenges now facing Labour will be to get economic growth back on track, boost business and public investment, all while managing a legacy of close to record high public debt and budget deficits and an external macro environment dominated by global tensions and increasing uncertainty.

On the bright side, the large parliamentary majority has given Labour a mandate to take bold moves and start from a clean slate to get the UK back on a path of growth and increasing optimism.

This all comes after we saw the European Central Bank (‘ECB’) cut its rates by twenty-five basis points on June 6th, taking the benchmark rate down to 3.75 percent.

This cut was perhaps fairly anticipated as we had stated in QED’s last newsletter but was nonetheless significant on several fronts.

First and foremost, this is the first time that the ECB has cut rates in close to five years. So, after half a decade of either flat or rising rates, policy conditions in the Eurozone are easing.

Secondly, and remarkably, this is also the first time that the ECB has moved to either cut or raise rates before the U.S. Fed. Historically the ECB was always more of a follower, and this marks a break from this trend as reported by Bloomberg and other market observers.

And finally, while the ECB may have acted before the Fed for the first time, it was by no means the first to do so among other central banks. The Bank of Canada had announced a rate cut the day before, and in the preceding weeks, central banks in Brazil, Mexico, Chile, Switzerland, and Sweden had all reduced rates. There now seems to be a global wind of easing blowing through the world.

So, is this a sign that after a long winter of rising rates and inflation, we are finally saying hello to a summer of decreasing rates and more economic growth? And what are the implications of all of this for fintechs?

Well, while summer is literally here, at least in the Northern Hemisphere, from a figurative perspective there is still room for caution. The ECB signalled that rates will remain higher for some time still, and the biggest worry here is clearly negotiated wage growth in the Eurozone which grew at a record 4.7 percent in the quarter. The ECB will keep a keen eye on wage growth, and only if that shows signs of moderating may consider another cut, perhaps in September.

And when it comes to economic growth, while there have been more positive news coming out of the Eurozone lately, the fact that the secular GDP growth trend in the US has been higher remains. Nonetheless, the ECB also lifted its growth forecast for this year from 0.6 percent to 0.9 percent, and expects a growth of 1.4 and 1.6 percent in 2025 and 2026, respectively. Not exactly, venture-style rocket ship growth rates, but certainly better than a recession!

And finally, the implications for fintechs will likely be positive on balance. Klarna, the Swedish buy-now-pay-later(‘BNPL’) platform where QED invested and our managing partner Nigel Morris served on the board, is widely rumoured to be in the public offering pipeline. As those of you who follow QED’s publications will know well, lower rates make the BNPL proposition much easier to execute, so on that front at least, this can certainly be viewed as good news for fintech. And this in turn, should provide some very welcome tailwinds for fintech IPOs that are in the pipeline, whether it be Klarna or other growth companies. And more IPOs will continue to reinforce the positive feedback loop for the fintech startup ecosystem with new capital, new ideas and new founders coming together to create the unicorns of tomorrow.

More broadly, of course, it is important to keep in mind that rates go through cycles, and the best way to build resilience is via the time-tested tonics of a strong culture, strong unit economics, and high customer satisfaction. Rates may move around, but in the world of building long-lasting companies, some fundamentals never change.