The release of the Spring 2022 Economic Forecast by the European Commission is anything but rosy. It paints a sombre picture of the economic outlook for Europe and highlights the uncertainty that faces the region. The report places a specific focus on the Russia-Ukraine war, noting that the conflict has derailed any hopes of strong post-pandemic economic recovery. The EU is naturally the first of the advanced economies to feel the impact of Putin’s hostilities, given its geographical proximity to Russia and Ukraine, its heavy reliance on imported fossil fuels, especially from Russia, and its high integration in global value chains. Substantial inflows of people fleeing the war – as many as five million in the first 10 weeks after the start of the war – pose additional challenges to the region.
The forecast suggests a prolonged period of high inflation coupled with low growth. The region is expected to grow by 2.7% in 2022 and 2.3% in 2023, in contrast to the 4% and 2.8% forecasted in the EU’s Winter Economic Forecast. The EU’s inflation forecasts have also been adjusted significantly higher – the Harmonised Index of Consumer Prices inflation for the region is now expected to average an all-time high of 6.8% in 2022, before declining to 3.2% in 2023. In the euro area, inflation is projected at 6.1% in 2022 and 2.7% in 2023, compared to the respective 3.5% and 1.7% predicted in the Winter Economic Forecast.
While rising energy prices are the main culprit for high inflation in Europe, price pressure is spreading across several other sectors and products, with cost increases dampening household purchasing power and subsequently lowering demand. This position is exacerbated by the expectation that growth in compensation will lag inflation throughout 2022 and cause real (i.e. net of inflation) household income to decrease by 2.8%.
ADDITIONAL RISKS HIGHLIGHTED IN THE REPORT INCLUDE:
- further increases in import prices accelerating stagflationary forces brought about by the Ukraine war. Greater than expected second-round effects could then amplify these impacts;
- continued strong inflationary pressures leading to tighter financial conditions than those underpinning the forecast, with a negative impact on domestic demand and strains on public budgets and the banking sector;
- economic activity in the US and China decelerating at a greater rate than expected, further denting growth in the EU;
- COVID-19 continuing to cause economic and/or social disruption.
It is not all doom and gloom, however. Some positives in the report include the potential for private consumption to prove more resilient to increasing prices if households were to use more of their savings for consumption, while investments fostered by the European Commission’s Recover and Resilience Facility could generate a stronger impulse to activity through stronger cross-sector and cross-country spillovers. Lastly, an accelerated reduction of fossil fuel dependency and a green transition could reduce the negative impact of high energy prices faster than assumed.
DATA IN A NUTSHELL
The British economy unexpectedly grew by 0.5% month-on-month in May, recovering from a 0.2% contraction in April, and beating market forecasts. Services output grew 0.4% in May, led by human health and social work activities. This was mainly due to a large rise in General Practitioner appointments, which offset the continued scaling down of the NHS Test and Trace and COVID-19 Vaccination Programmes. Production grew 0.9%, driven by growth of 1.4% in manufacturing and 0.3% in utilities. Yearly, the British economy expanded 3.5% year-on-year in May, beating market forecasts of a 2.7% increase.
The annual inflation rate in the US accelerated to 9.1% in June, its highest level since November of 1981, and up from 8.6% in May. The reading was above market forecasts of 8.8%. Energy prices soared by 41.6%, their highest level since April 1980. Energy costs were bolstered by a rise in gasoline of 59.9%, its largest increase since March 1980 with fuel oil up 98.5%; electricity up 13.7%, its largest increase since April 2006; and natural gas jumping 38.4%, the largest increase since October 2005. Food costs surged 10.4%, their highest jump since February 1981. Claims for unemployment benefits increased by 9,000 to 244,000 the week that ended 9 July, their biggest jump since November 2021, as more companies announce job cuts amid economic uncertainty.
Britain’s 10 year Gilt yield rose slightly, to above 2.1%, hovering a tad above the five-week low reached earlier in the month, as investors continue to assess the impact higher interest rates will have on growth and keep an eye on the election race for the UK’s next Prime Minister.
The 10 year US Treasury note yield, which sets the tone for corporate and household borrowing costs worldwide, consolidated around the 3% level, as investors assessed the outlook for tightening monetary policy after a hotter-than-expected US inflation reading. The gap between two and ten year bond yields widened by almost 30 basis points, its largest in over two decades. This closely watched part of the US yield curve, viewed as a proxy for recession risks, has been inverted in the last several trading sessions, meaning that the return on 2 year bonds is higher than that on the 10 year equivalent and implying that the likelihood of a recession has increased.
STOCKS SUBDUED AS UNCERTAINTY LINGERS
Stock futures contracts tied to the three major US indices were down roughly 1% on Thursday, putting Wall Street on track to extend losses. Investors reassessed the outlook for tightening monetary policy while awaiting a flurry of corporate earnings reports, as markets digest the prospect of a 100 basis point rate hike by the United States Federal Reserve (Fed) later in July. In addition, the Fed’s Beige Book report, which comes out eight times a year, highlights fears of an impending recession, amid soaring inflation. On the earnings side, JPMorgan Chase missed Wall Street expectations on earnings and revenue, sending shares of the bank down almost 4% in premarket trading. In regular trading on Wednesday, the Dow lost 0.67%, while the S&P 500 and Nasdaq Composite fell 0.45% and 0.15%, respectively.
Shares in London remained under pressure on Thursday, with the benchmark FTSE 100 bottoming below the 7,150 level, dragged down by the healthcare sector. Investors remain worried about the implications of tighter monetary policy on growth momentum after a hotter-than-expected US inflation reading boosted bets of an even more aggressive Federal Reserve. Barratt Developments and Admiral Group were among the biggest laggards on the index, down over 3% each.
European stocks remained under pressure on Thursday, with both the DAX and the STOXX 600 shedding over 1%. With all eyes on growth and inflation, a falling euro could drive inflation in the euro area even higher, which could force the European Central Bank (ECB) to increase rates more aggressively. Shares of energy, banking and mining companies were among the worst performers, followed by healthcare, telecoms and real estate.
COMMODITIES IN THE RED
Brent Crude futures traded nearly 2% softer at $97 a barrel, amid concerns that high-interest rates would cut fuel demand further. International Energy Agency data, released this week, highlighted weakening US demand with the supply of oil falling to 18.7 million barrels per day, its lowest level since June 2021. Meanwhile, China’s COVID restrictions continue and these curbs are expected to also weigh on oil demand. China’s daily crude imports in June sank to their lowest level since July 2018 as refiners anticipated a hit from lockdown measures, according to Reuters. On the supply side, however, fundamentals still point to a tight market, amid disruptions in Russia and Libya and spare capacity in OPEC, the organisation of the petroleum exporting countries.
Gold prices fell nearly 2%, to trade below $1,710 an ounce on Thursday, hitting levels not seen since April of 2021. Gold has been pressured by a rising dollar as investors increasingly bet that the Fed will deliver a 100 basis point interest rate hike at the end of July to curb soaring consumer prices.
Copper extended its retreat to $3.30 per pound, its lowest level in nearly 20 months. The metal is being weighed down by heightened concerns of a global economic slowdown and amid resurgent COVID-19 restrictions in China. An impending global recession could also jeopardise China’s infrastructure push, as the country aims to build a total of 461,000 kilometres of its national highway by 2035, driving down the metal’s consumption further. On the supply side, copper output at Peru’s huge Las Bambas mine has returned to normal levels after a two-month shutdown due to protests that ended last month.
EURO IN THE DOLDRUMS
The euro hovered just above parity to the dollar, trading around $1.003 after falling below the key $1 level for the first time in 20 years on Wednesday. It was dragged down by recessionary fears and bigger policy discrepancies between the ECB and the Fed. Soaring natural gas prices, amid uncertain energy supply from Russia, are weighing on the EU’s GDP growth, making it more difficult for the ECB to tighten its monetary policy. The ECB is only expected to raise key rates by 25 basis points later this month, the first increase in more than 11 years, while the Fed is seen delivering another 100 basis point hike at the end of July, following a cumulative 150 basis point increase in rates since March. Meanwhile, political turmoil erupted in Italy, after Prime Minister, Mario Draghi, said he would not head an administration without the 5-Star Movement on board.
The US Dollar Index (DXY) jumped more than 1% to top 109 on Thursday, a fresh 20-year high, amid increasing bets that the Fed will deliver a 100 basis point rate hike in the fed funds rate later this month, which would be the largest increase since the central bank started directly using overnight interest rates to conduct monetary policy in the early 1990s. The DXY is up more than 13% this year so far.
The British pound weakened below $1.19, its lowest level in over two years, amid the broad rush to the safety of the dollar on the back of higher-than-expected inflation readings. The pound has been declining since May 2021. On the political front, the UK’s ruling Conservative Party started its race to find its next leader and the future Prime Minister, with six candidates now in the running, including former Finance Minister Rishi Sunak.
The pound started the day trading at 1.1840/$ and 1.1795/€.
Written by Citadel Global Director, Bianca Botes
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