The Fed’s very political cut, BoE forced to pause and Munich Auto Show blues for European car makers

As the Fed shifts focus to the labor market and faces increasing pressure to lower rates, we now expect frontloaded back-to-back 25bps rate cuts at its next two meetings (16-17 September and 28-29 October), followed by two others in H1 2026 (taking the Fed Funds Rate to 3.5%, in line with our previous scenario). But while job creation has weakened, tighter immigration has also drastically reduced labor supply, keeping the labor market relatively balanced. We expect unemployment to peak at 4.9% by Q1 2026, slightly above the equilibrium rate. Moreover, combined with monetary easing, the Big Beautiful Bill should also support GDP growth by +0.5pp next year (to +1.6%). And above all, inflation will remain above target (at 2.9% in 2026) as around three-fourths of the costs of tariffs are likely to be passed on to consumers by end-2026. In addition, medium-term household inflation expectations remain high, feeding further into inflation risks, which could even force the Fed to re-hike interest rates. In this context, market expectations of a terminal rate at 3% by July 2026 look too ambitious.  

As inflation remains stubbornly high, the BoE’s strategy of one rate cut per quarter is looking increasingly untenable, with the policy rate currently 70-90bps lower than it should be considering inflation and economic slack. To restore its inflation-fighting credentials, we expect the BoE to enter a prolonged pause at its next meeting on 18 September, lasting until Spring 2026, with inflation not likely to fall convincingly below 3% before then. But to prevent long-term yields from rising further, the BoE will slow down its quantitative tightening (QT) from GBP100bn to GBP60-70bn annually. Nevertheless, we see limited scope for the 10-year Gilt yields to go below 4.5% as the fiscal deficit will remain close to -5% of GDP in 2026 (from -5.7% in 2025) and public debt will rise further to 105% of GDP. In this context, markets will be paying close attention to fiscal discipline in the Autumn Budget, in which we expect the government to announce at least GBP20bn of fiscal consolidation measures.

As the biennial auto fair kicks off, the European car sector is facing growing pressure on its domestic and export sales. European new car registrations are down -0.7% year-to-date and Germany, France and Italy are shrinking by -2%, -8% and -4% respectively. Overall, domestic sales remain roughly -25% below their 2019 level and the upside risks from electric‑vehicle adoption remain limited: in nearly 60 % of EU countries, EV penetration is under 15%. Price gaps, high electricity costs and patchy charging infrastructure continue to favor hybrids, where Chinese competition is getting stronger. They have doubled their European market share to about 6% and undercutting incumbents with models priced below EUR30,000 could push this to 10–11 % of Europe’s hybrid/EV segments by year‑end. The shift of powertrain priority is biting margins, contributing to the over 200bps squeeze reported by European automakers in H1 2025. Meanwhile, Chinese competitors are now also dominating their home market (70% market share) and regaining market shares from European brands. This is expected to result in at least EUR4bn in potential revenue losses for the sector this year. To add to this, trade tensions with the US threaten up to EUR5bn in revenues for the European auto sector. With operating margins already down to a medium-low single digit, manufacturers must balance cost‑cutting with urgent investment in batteries, software and autonomous technology.