How will EU auto stocks react to central bank easing? Via Investing.com

European auto stocks may not experience an immediate boost following the central bank’s interest rate cut, despite hopes for increased affordability of new vehicles, Morgan Stanley pointed out in a note to clients on Wednesday.

Historically, the sector does not react quickly to interest rate cuts, and weak underlying demand, combined with deflation in new and used car prices, usually takes time to resolve.

“Lower rates alone cannot save the auto sector,” Morgan Stanley analysts noted in their report, noting that while lower rates may help car affordability, “underlying demand may take several quarters to improve.”

Consequently, analysts remain cautious on European OEMs and see margin risks looming over the sector.

Morgan Stanley’s macro team forecasts that the Federal Reserve will implement its first interest rate cut of 25 basis points at the Federal Open Market Committee (FOMC) meeting in September, cutting the policy rate to 5.125%.

Analysts expect a total of three such cuts before the end of the year. However, analysts warn that this cheaper money may not be enough to offset pressures in the auto sector.

The report also points out that lower rates tend to coincide with falling average selling prices (ASPs) as OEMs move to defend their market share.

This can help improve affordability, but could present a challenging margin environment. “We are already reflecting lower rates in our new car affordability estimates, helping but not fully addressing industry pressures,” the report said.

Moreover, the study shows that OEMs, as credit-sensitive stocks, may not benefit from falling bond yields as much as expected.

“Lower bond yields, while helpful for affordability, may be the consequence of lower aggregate demand and are not always associated with tighter spreads,” Morgan Stanley said, noting that “more optimistic would be signs of reflation in China”.

Morgan Stanley data also shows that European auto stocks underperform when yields fall rapidly. “The relative performance of autos averages -7% in months when 10-year bond yields fall more than 50 basis points,” the report said, indicating that rising bond yields were in terms of historically more supportive for the sector.

As such, analysts suggest that for investors with a multi-year horizon, the sector’s risk-reward profile remains weak.

“We continue to believe that margin downgrades make the risk-reward ratio in the sector quite weak,” the report said, warning that the current weak demand environment and high margin estimates still pose risks for European automakers.

Despite the pressure on OEMs, Morgan Stanley’s analysis also touched on the role of inflation. The auto sector has previously benefited from rising prices, but “recent data highlights that the fundamental backdrop for auto prices is now deteriorating,” with US new car price inflation turning negative and dealer incentives increasing.

“We see that affordability is still stretched,” Morgan Stanley said, citing weaker underlying demand for new cars at current prices. The report also stated that Bayerische Motoren Werke AG ( WA: )’s recent profit warning pointed to weak demand, particularly in China, as a key factor affecting margins.