May 26, 2023 | 15:11
Meantime, Over in Europe
With the market’s attention solely focused on the U.S. debt ceiling talks this week (understandably so), a couple of other brow-raising developments were happening elsewhere.
It turns out that Germany was in recession at the turn of the year. Thanks to the magic of revisions, and more cautious consumers, Q1 real GDP was revised downward, and showed a 1.3% a.r. contraction (initially pegged as flat), on the heels of Q4’s 2.1% drop. It didn’t come as a complete and utter shock as worries were percolating after some confidence indexes flagged a problem. The investor-based ZEW Survey has fallen for three consecutive months and, in May, saw its first negative reading for the year. Then, the CEO-based ifo Survey declined for the first time since October, with particular emphasis on ‘expectations’, and accompanied by the warning that “the mood in the German economy has taken a significant hit”. Clearly, survey respondents were onto something. Interestingly, the composite PMI did not pick up on this—it expanded in Q1, and has continued to improve in Q2, with May’s reading the highest in over a year. France stumbled in May but activity has been growing for the past four months. (Separately, Greece has been blithely floating along in the background after last weekend’s very market-friendly elections, with 10-year yields trading about 50 bps through Italy, the biggest gap in over two decades.) Meantime, the ECB is shrugging off the Euro Area’s largest economy’s problems and is clearly fully intending to move forward with tighter monetary policy. Some key quotes this week include “We are not done yet, we are not pausing”, “We expect to turn the corner, but I wouldn’t say we reached that corner quite yet”; “Inflation momentum is still persistent”; “we still have some way to go”, and so on. Interestingly, France’s Francois Villeroy de Galhau, whose views are more middle-of-the-road, brought up September. “We have three possible Governing Councils either for hiking or pausing.” All in, we remain comfortable with our expectation for 25 bp rate hikes at the June and July meetings and, to borrow from the Netherlands’ Knot, are “open-minded” for September.
In the U.K., a recession is no longer expected, but it cannot be entirely dismissed, not with inflation still at multi-decade highs. Yes, headline inflation finally retreated back to single-digit territory for the first time since last August, but food prices continue to soar. In March, the 19.6% y/y surge was the fastest since 1977 and there was barely any change in April (at +19.3%). All the basics—milk, cheese and eggs, vegetables, fruit, breads and cereals, meat and fish—grew at a double-digit pace. Blame it on imports, or “greedflation”, or soaring immigration, but sources on the ground also noted the lack of product as increased regulations to allow imported food into the country are slowing things down dramatically. Meantime, core CPI, which excludes food, energy, alcohol and tobacco, is up 6.8% y/y, the fastest increase since 1992. We now look for the BoE’s Bank Rate to rise to 5.25% by year-end, with 25 bp hikes at each of the next three meetings, or one more than we expected before the latest inflation results. Governor Bailey warned that if the BoE does not get inflation “back to target and… under control, it gets worse.”