The latest ECB survey of professional forecasters (SPF) shows a downward revision of the growth outlook and an upward adjustment of the inflation forecast. For next year, the real question is not about the direction of inflation but about the speed and extent of its decline. Slower than expected progress could convince the ECB of the need for more rate hikes than currently priced by markets, implying a bigger output cost of bringing down inflation. Disinflation could indeed take longer than expected. Over the past two years, a variety of factors have led to an exceptionally elevated but also broad-based inflation. Not all shocks have occurred simultaneously and it often takes time for them to work their way through the system, from the producer to the wholesaler to the retailer
A sum-of-the-parts analysis, which is popular in corporate finance, has made its way in the world of central banking, reflecting concern that the multitude of synchronous rate hikes could have a combined tightening effect that is larger than the sum of its parts. To the extent that inflation in a given country is largely a function of global slack, these hikes could cause an unexpectedly large decline in inflation. Rising import prices due to currency depreciation are another factor because they could force countries to tighten monetary policy. Confidence effects may also play a role, especially at the level of export-oriented companies.To address these risks, central banks could insist that synchronous rate hikes should moderate inflation expectations globally
Inflation jumped sharply in September, moving into the symbolic territory of double digits (10.1% y/y), slightly above expectations (10%). The rise in inflation is expected to continue as it is widespread in the economy. Furthermore, core inflation rose significantly in September (+0.5 points) to 7.5% y/y. Nevertheless, inflation continues to weigh on economic activity.
The detailed inflation figures for September in Spain confirm the changes in price momentum over recent months. The rise in energy prices, while still very high (22.4% y/y), has eased since last March – at that time the increases had peaked at 60.9% y/y. Conversely, the annual CPI increase for food and non-alcoholic beverages has accelerated (14.4% y/y compared to 6.8% y/y in March). As a result, and for the first time since the outbreak of the war in Ukraine, the rise in the cost of food products has become the leading contributor to inflation, by 3.4 percentage points (p.p.), compared to 2.4 p.p. for energy. However, harmonised total inflation fell from 10.5% in August to 9.0% in September.
Eurozone inflation reached the 10% y/y mark in September, according to Eurostat’s preliminary estimate, the highest-ever reading since the zone’s inflation rate has been measured. Energy prices were a major factor (up 40.8% y/y). In parallel, food prices rose at an increasingly rapid pace, with the harmonised index (also including alcohol and tobacco) up 11.8% y/y in September. Some of this increase in food prices stemmed from the impact of the surge in energy prices on the sector’s production costs. Even so, supply-side constraints linked to production difficulties also appear to have had a hand in this
In France, inflation fell to 5.6% year-on-year in September after reaching a high of 6.1% in July, but its decomposition has changed. Food prices (with a year-on-year increase of 9.9% in September) became the main contribution to inflation for the first time (representing a third of the 5.6% figure observed in September), exceeding that of the energy component, the reduction of which owes much to the discount applied to the litre of fuel (which grew from 18 to 30 cents). In 2023, the increase in regulated gas and electricity tariffs will be capped at 15% instead of 120%, which will prevent 5 inflation points (overall), according to our estimates.
Accelerating growth, slowing inflation, falling unemployment and the interruption of monetary tightening differentiate Brazil from most of the world’s major economies. These developments, which are largely attributable to fiscal stimuli (higher social transfers, reduction in taxes and fuel prices), are complicating the task of monetary authorities by partially diluting the restrictive effects of their policy. In the second half of the year, the maintenance of fiscal stimulus should again help limit the slowdown in activity. Brazil’s solid economic performance has allowed financial assets to hold up well despite the general elections and a deteriorating global environment.
Persistent inflation and the rapid and sustained rises in interest rates are hitting the US economy hard. However, business climate surveys are recovering, albeit modestly, and consumer confidence has improved for the second consecutive month. Business climate indices rebounded in September, although without moving back into growth territory. The composite PMI recovered significantly (+4.7 points compared to August) to stand at 49.3, mainly driven by the strong growth in the services sector PMI (+5.5 points, to 49.2) and, to a lesser extent, by a slight improvement in the manufacturing PMI (+0.2 points, to 51.8).
Dark clouds are continuing to gather over the Eurozone economy. The first set of data available for September is not positive and this can be seen in our Pulse. Looking at the survey data, the blue area (recent conditions) is shrinking when compared to the dotted line (conditions four months earlier) and even, on some indicators, when compared to the grey dodecagon (the long-term average). The opposite is true for the inflation data. In fact, inflation reached a new level, at 10% y/y in September according to Eurostat’s preliminary estimate. Not only did inflation reach double figures – which was predictable, but still bad news – but its 0.9–points rise compared to July was broad-based across all its main components.
Inflation has been the dominant economic theme for months, but, under the influence of aggressive monetary tightening, one can expect this won’t last. At the same time, recession concerns are mounting. Central bankers acknowledge that their action may cause a technical recession, a huge majority of US CEO’s expect a recession and consensus forecasts show an increased recession risk in the US and even more so in the euro area. The recession narrative should lead to a wait-and-see attitude, of putting spending and hiring decisions on hold and creates a mutually reinforcing negative interaction between hard data and sentiment. A key condition for this to end is growing belief that central banks will have done their job and can afford to stop tightening
Following a second contraction in its GDP in Q2, the outlook for the US economy is at least uncertain. Inflationary pressures are showing signs of easing, but the pace of disinflation could be longer than expected. While consumer confidence recently paused its downward trend and in fact recovered slightly in August, business surveys show a sharp decline in sentiment, particularly in the manufacturing sector. The Federal Reserve has continued the rapid rise in its fed funds rates, which are now at restrictive levels.
The current unprecedented combination of shocks (inflation, health crisis, geopolitical issues, energy crisis, climate, monetary issues) is likely to overburden the Eurozone resilience and push the region into recession over the coming quarters. The deterioration in confidence surveys this summer provides an early indication of this likely outcome. However, we expect the recession to be limited in scope, in large part due to budgetary support. This recession should be followed by a moderate recovery as the various shocks start to ease. Faced with the continued surge in inflation, the ECB has moved up a gear
During the first half of 2022, the Italian economy has gradually gained strength. In Q2 2022, the real GDP was 1.1% higher than in Q4 of 2019. The carry-over for 2022 is 3.5%. The recovery that resulted was widespread in a variety of sectors. Construction continued to grow, recording a robust increase in comparison with the pre-COVID level, while both manufacturing and services increased as well, benefiting from the recovery of tourism. The overall outlook for the Italian economy has become more uncertain. Households and firms are extremely cautious. In the three months ending in July, industrial production fell by more than 1.5% q/q. The value of retail trade continued to rise, while the volume of sales declined, suffering from the acceleration of inflation.
Spain is unlikely to avoid a difficult winter. Although its economy is structurally less vulnerable to energy shortages, the inflationary shock is severe and is not slowing down, with an inflation rate of over 10% in August. The rise in non-energy prices is amplifying relentlessly. Despite government action, the decline in purchasing power for Spanish households will be among the biggest in the Eurozone. Although tourism is likely to have helped business to cope with the third quarter, we are expecting a contraction in the fourth quarter of 2022, which is likely to continue through the winter. Job creation was strong again this summer, but opinion surveys are also pointing to a downturn on the way.
Belgian GDP grew by 0.2% in the second quarter of this year. Private consumption continued its upward trajectory in the first half of 2022 but is expected to slow down as inflation remains at an all-time high. Higher labour and energy costs are weighing on firms, with investment expenditures once again below pre-pandemic levels. A recession as from the end of this year looks unavoidable. Active fiscal policy should ensure it remains a shallow one but the cost to public finances will be sizeable.
With a relatively limited risk of energy shortages, Portugal should record some of the largest economic growth in the eurozone this year. A number of favourable factors are driving these growth levels. There has been substantial carry-over growth from 2021 and real GDP rose sharply in Q1 (+2.4% q/q), before stabilising in Q2. The recovery in tourism has also boosted business activity this summer. Despite the aid measures for households and businesses, which the government estimates are worth EUR 4 billion so far in 2022, there should be a slight surplus on the primary budgetary balance for this year
Switzerland differs from other European countries in that it has significantly lower inflationary pressures, protected as it is by its strong currency and by resilient business activity which should continue to grow for the rest of 2022 and during 2023. Although the Swiss National Bank (SNB) is likely to argue that 3.5% inflation year-on-year in August is a reason to raise its key rate by 75 bps on 22 September, and so exit from its policy of negative interest rates, it is unlikely that this monetary tightening will last over the longer term, as inflation is already showing signs of slowing down.
The tight US labour market plays a crucial role in the effort of the central bank of bringing inflation back to target. Slower growth in labour income should lead to slower demand growth, whereas smaller wage increases will ease pressure on corporate profit margins and reduce the need for companies to charge higher prices. The labour market is characterized by a dynamic interaction between job openings, unfilled vacancies, voluntary departures (quits) and layoffs. In the US, unfilled vacancies and the quits rate have started to decline and one should expect that this dynamic will gather pace, causing a slowdown in wage growth. The question remains to what extent this will bring down inflation, which is why the Federal Reserve’s policy is completely data-dependent.
In recent months, the huge and rising gap between observed and target inflation has confronted central banks with an urgency to act. It could be called the panic phase of the tightening cycle. What followed was a swift succession of significant rate increases. Tightening was frontloaded, rather than gradual, to avoid an unanchoring of inflation expectations. This perseverance phase will be followed by a long wait-and-see attitude once the terminal rate -the cyclical peak of the policy rate- will have been reached. During this patience phase of the monetary cycle, the central bank will monitor how inflation evolves. With the risk of further rate hikes having declined, the government bond market should stabilize, which can have positive spillovers to other asset classes
Inflation in Spain shows no signs of abating. Consumer price inflation remained above 10% y/y in August, at 10.5% (national measure). Although slightly lower when compared to July (10.8% y/y), this decline was mainly due to a fall in private transport costs (-3.5% over one month), the result of lower fuel prices at the pump. Conversely, the increase in food prices (and non-alcoholic beverages) accelerated, by 0.3 of a point to 13.8% y/y, with increases seen in dairy products, bread, and corn. The underlying measure (which excludes energy and perishable foods) also rose, from 6.1% y/y to 6.4% y/y. Prices also continue to be very dynamic in the property sector.
There is a large consensus that 2023 should be a year of disinflation. Monetary tightening will play an important role in that respect. However, it is difficult if not impossible to estimate when and at which level of official interest rates, inflation will have sufficiently converged to target. This explains why the Federal Reserve and the ECB have decided to frontload their rate hikes. It should reduce the risk of inflation surprising to the upside. A lot will depend on how inflation expectations evolve. Recent research shows that firms use price information to which they are directly exposed to form an opinion of future, aggregate inflation
The French economy sprung a pleasant surprise in view of the headwinds that have been picking up since the start of 2022. Growth was 0.5% Q/Q during Q2, mainly due to the upturn in tourism and leisure business activity after COVID restrictions were lifted from March onwards. However, inflation continued to have an impact, as seen in the further fall in consumer purchasing power during Q2 (-1.1% Q/Q, following on from -1.6% during Q1). This inflation hit 6.1% Y/Y in July before falling back to 5.8% in August (according to the French National Institute of Statistics and Economic Studies (INSEE) national measurements).
Recent economic data paint a picture of increasing concerns about the economic outlook. In the US, high inflation and rising interest rates play a key role. In the euro area, the same factors play a role -although interest rates are still below those in the US- but skyrocketing energy prices and gas supply disruption are additional forces that should drag down growth. Easing price pressures in business surveys are a hopeful development but selling price expectations remain nevertheless exceptionally high given the weakening of order books. This could point to input price pressures that force businesses to charge higher prices to protect their margins. It is to be feared that slowing demand will make this increasingly difficult, forcing companies to cut back on investments and new hirings
The US labour market continues to perform well. The unemployment rate stood at 3.7% in August, up slightly from 3.5% in the previous month. Total nonfarm payroll employment growth is slowing down but remains significant (+315k m/m), particularly in professional and business services, health care, and retail trade. The labour market’s resilience to the slowdown in growth is an important element in mitigating the impact of the rising cost-of-living.
An exceptional response to exceptional circumstances. There is a high probability that the ECB will raise its policy rates by 75 basis points at its meeting on 8 September. The fact is that the ECB has little choice but to respond with extraordinary measures to the continuing surge in inflation, despite the increased risk of recession. This is putting into practice the hawkish statements of Jackson Hole and the unconditional determination displayed to maintain price stability.
