The recurring nightmare for European policymakers that their economies will become crippled by inflation-impaired lethargy just won’t go away.
(Bloomberg) — The recurring nightmare for European policymakers that their economies will become crippled by inflation-impaired lethargy just won’t go away.
Mounting evidence across the region of growth running aground and consumer prices remaining untamed is confronting officials in Frankfurt and London as they return from summer breaks to reassess whether interest-rate settings are where they should be.
The news flow has been dismal enough for investors to resume focus on worries that haunted finance chiefs in 2022, asking if the threat of stagflation is once again stalking the continent.
As central bankers know only too well, even when they shirk from saying it out loud, that label for the headache of lackluster expansion and unrelenting inflation that plagued the 1970s represents a host of troubles — even in its mildest form.
“The euro area is stuck in stagflation, and we’re not going to come out of it any time soon,” said Karsten Junius, chief economist at Bank J Safra Sarasin in Zurich. “In the UK, everything is going wrong.”
The market response so far suggests lingering concerns that central banks are losing appetite to keep raising borrowing costs come what may. Data on Thursday pointing to price growth cemented above 5% in the euro region was greeted by pared-back bets for a rate hike in two weeks’ time.
Articulating the quandary were comments by European Central Bank official Isabel Schnabel — the policymaker there in charge of markets — who admitted the economic outlook is souring while insisting that inflation is “stubbornly high.”
Bank of England Chief Economist Huw Pill used the same words to describe the level of core consumer price growth in the UK, while also warning his colleagues not to inflict “unnecessary damage” on the economy.
Both of them spoke days after the US Federal Reserve’s meeting in Jackson Hole, Wyoming, where the US central bank chief, Jerome Powell, and ECB President Christine Lagarde, each acknowledged that after more than a year of monetary tightening, inflation is still too elevated.
Euro zone policymakers will be first to cast a judgment on the where the threats lie, with a decision on Sept. 14 described by Finnish official Tuomas Valimaki as “totally open” on whether another rate hike is needed. The BOE will meet a week later, a day after the Fed.
The current juncture revisits concerns that troubled the region when it first confronted the specter of surging gas prices in the wake of Russia’s invasion of Ukraine.
When Group of Seven finance chiefs met in May 2022, they discussed what to do to “avoid stagflation scenarios,” in the words of the gathering’s host, German Finance Minister Christian Lindner.
That alarm re-emerged at the July decision of the ECB, according to minutes of that meeting released on Thursday. “The concern was also raised that the economy might be entering a phase of stagflation, in contrast to a more benign scenario,” according to the account.
Such worries are overshadowing financial markets, after a slew of reports indicating weakening growth in the UK and the euro zone — such as declining purchasing manager indexes — and faster-than-expected inflation in continental Europe’s two biggest economies, Germany and France.
That’s showing up in the performance of sectors whose fortunes are most closely linked to the economy. Germany’s DAX, home to the manufacturing bigwigs of Europe, has been underperforming and eyeing its worst monthly performance since December.
In money markets meanwhile, the conclusion that central bankers are shifting against much more ratcheting up in their policy against inflation is taking hold. The implied chance of one final ECB increase this year fell to 70% on Thursday. The odds that would come at September’s meeting slumped to just one-in-three.
“The big concern now is that the European outlook is looking increasingly stagflationary, with inflation remaining stubborn whilst there’s few signs of growth either,” Deutsche Bank analysts including Jim Reid wrote in a note.
Stagflation bodes poorly for the euro. Until recently, higher-than-expected euro-zone inflation readings had boosted the currency, but that dynamic is changing.
Traders have already started abandoning the euro at pace. The single currency fell as much as 0.5% to $1.0863 on Thursday, taking losses from a peak in July to almost 4%. A much bigger drop could be on the cards, if analyst forecasts materialize after they cut their median outlook for the currency for the first time in six months.
What Bloomberg Economics Says…
“The data keeps the case for a rate hike on the table and we continue to expect the ECB will end this tightening cycle with a 25-basis-point increase in September, taking the deposit rate to 4%.”
—Maeva Cousin, economist. For the full report, click here
As for the UK, the BOE is also grappling with slowing growth and inflation that remains well above the 2% target, underpinned by a hot labor market.
After robust wage data in August, Fitch Ratings observed an “increasing risk that the UK will experience a period of stagflation — with low growth and rising unemployment coinciding with high inflation.”
While traders see a quarter-point hike next month as almost a done deal, bets on the peak rate have been slashed to around 5.80%, compared to a 6.60% peak in early July. The pound has slipped from a recent peak of $1.3142 seven weeks ago to around $1.267.
Three weeks of trading before the BOE meets will still allow for plenty of volatility around that view, not least with verdicts from the ECB and the Fed on the risks likely to focus investors first.
Gilles Moec, chief economist at AXA Investment Managers, told Bloomberg Television that the quandary for officials in the euro zone is looking increasingly frustrating.
“We now know that monetary policy is working, and it’s worked through the economy, because the economy is not doing well,” he said. “But right now there is no impact whatsoever on inflation, and this is the big issue we have. We have more slowdown than in the US — with more inflation.”
–With assistance from Lucy White, Jonathan Ferro, Tom Keene, Kailey Leinz, Sonja Wind, Sagarika Jaisinghani, Alexander Weber, James Hirai, Blaise Robinson and Constantine Courcoulas.
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