Weekly Wrap: A war on inflation ensues

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Written by Citadel Global Director, Bianca Botes

Interest rates across the globe continue on an upward trajectory, as central banks unite in their fight against inflation. This week saw the European Central Bank (ECB) and the South African Reserve Bank (SARB) both hike rates, as each battles its own war on inflation.

Key themes for this week include:

  • SARB hikes interest rates by 75 basis points
  • ECB hikes interest rates by 50 basis points
  • United States (US) jobless claims hit eight-month high
  • Rebound in gold expected to be short-lived
  • Dollar retreats on the back of euro gains
  • South African rand treads water at 21-month low

INTEREST RATES IN FOCUS

The ECB and SARB both took centre stage on Thursday, as investors anxiously awaited the interest rate decision by the two central banks. With inflation at record-high levels, it comes as no surprise that markets anticipated a hike from both of these banks.

The ECB took the stage first, raising its three key interest rates by 50 basis points each. This was the first ECB rate hike since 2011 and ended eight years of negative rates. The Bank is trying to release the inflationary pressures brought on by COVID-19 supply constraints, which were then exacerbated by the war in Ukraine. Their main refinancing rate is now at 0.5%, while the marginal lending facility stands at 0.75%, and the deposit facility rate increased to 0.00%. While the ECB initially laid the groundwork for a 25 basis point hike during its June meeting, increasing inflationary risks swayed policymakers to take a more aggressive approach. Inflation in the euro area continues to climb at a record pace and is rapidly approaching double-digits. It hit 8.6% in June. The Central Bank noted that further normalisation of interest rates will be appropriate in the upcoming meetings, with markets anticipating another 25 basis point hike in September. The ECB’s Governing Council reiterated its strong commitment to its price stability mandate, and its target inflation rate of 2%.

In an effort to assist some of the financially strained countries in the economic zone, the ECB also agreed to provide extra help to the eurozone’s more indebted nations and approved a new bond purchase scheme called the Transmission Protection Instrument (TPI) which is intended to cap the rise in their borrowing costs and limit financial fragmentation. “The scale of TPI purchases depends on the severity of the risks facing policy transmission,” the ECB said in a statement on Thursday. It added, “The TPI will ensure that the monetary policy stance is transmitted smoothly across all euro area countries.”

Inflation in South Africa has also recently come into focus, as the country’s inflation reading broke well above the top end of the target band, hitting a whopping 7.4% in June, leaving little room for SARB to postpone a hike, or to even consider a hike below the 50 basis point mark. While inflation forecasts are on the rise, SARB reassured the nation, that it is committed to protecting South Africans against the deterioration of income. The higher-than-expected 75 basis point hike marks the fifth consecutive interest rate hike for the country. However, when questioned on why SARB is not increasing rates in higher increments, to counter the inflation trajectory, the governor stated that the economic outlook of South Africa remains fragile and needs to be considered in line with the inflation trajectory and that the committee believes that the 75 basis point hike is appropriate, given the current landscape. The governor also noted that the policy will change with the landscape, and should more aggressive action be needed, the bank will not hesitate to act accordingly. The hike now brings the benchmark repo rate to 5.5%, while inflation forecasts for the year were raised. The headline consumer price index (CPI) forecast has been revised higher to 6.5% in 2022, above the 5.9% projected earlier; 5.7% in 2023, up from 5%; and 4.7% in 2024 which is in line with previous forecasts.

SARB also stressed that consumers must remember that rate hikes come with a lagging effect, and the impact of rising interest rates should be given time to filter through and that it cannot be expected to counter inflation in a period of just two quarters.

Elsewhere, Ukraine kept interest rates steady at 25%, and Turkey held its rates firm at 14%. The People’s Bank of China (PBoC) held its key rates steady at 3.7% on one-year rates and 4.45% on five-year rates for corporate and household loans at its July interest rate fixing. The Central Bank continues in its efforts to provide ongoing support to China’s economic recovery in the wake of the COVID-19 outbreak. The Bank of Japan (BOJ) maintained its key short-term interest rate at -0.1% and 10-year bond yields at 0% during its July meeting. The BOJ reiterated that it will not waver to take further easing measures if needed.

DATA IN A NUTSHELL

The unemployment rate in the United Kingdom (UK) held at 3.8% in the three months to May, the same as in the previous period and marginally below market expectations of 3.9%, suggesting the country’s labour market remains robust, despite rising prices squeezing the cost of living. The number of people in employment increased by 296 000, the biggest gain since the three months to August of 2021. The number of full-time employees increased to a record high and part-time employees also rose. Also, the number of economically inactive people fell by 144 000, the biggest drop since the start of the Coronavirus pandemic. The annual inflation rate in the UK rose to 9.4% in June, marking its highest level since 1982 and slightly above market forecasts of 9.3%. The biggest price pressure came from the cost of motor fuels which increased by a record 42.3%, as average petrol prices rose by 18.1 pence per litre in June, the largest monthly increase on record since, at least, 1990.

In the United States (US), the number of Americans filing new claims for unemployment benefits jumped by 9 000 to 251 000 the week ending 16 July, the highest number of claims since November 2021, and well above market expectations of 240 000, pointing to a cooling labour market. The US Philadelphia Fed Manufacturing Index decreased for the fourth consecutive month to -12.3 in July, its lowest level since May 2020 and well below forecasts of a flat reading. The survey’s indicators for current general activity and new orders moved further into negative territory. The shipments index was positive and rose slightly, while the indices for inventories and unfilled orders were negative. The futures indicators suggest that firms expect overall declines in activity and new orders, but expect increases in shipments and employment over the next six months.

Looking at bond movements, the yield on the benchmark 10-year US Treasury note edged up toward 3% during the third week of July, as investors continued to weigh the outlook of tighter monetary policy. At the same time, recent economic data showed the US economy remains robust, despite strong inflation and rising interest rates. US Federal Reserve (Fed) policymakers enter a “blackout” period this week before the Federal Open Market Committee meeting on July 26th and 27th.

Britain’s 10-year Gilt yield hovered above 2.1%, after hitting a five-week low of below 2% earlier in the month. Investors continue to assess the impact of higher interest rates and the race for the next UK Prime Minister on the UK’s growth. BoE Governor, Andrew Bailey, opened the door for a 50 basis point hike in August, which would be the largest rate hike for the country since 1995.

The yield on the South African 10-year bond was just below 11%, not far from a two-year high of 11.1% hit on 19 July, ahead of the interest rate decision by the SARB.

Japan’s benchmark 10-year bond yield fell to 0.236% after the BOJ maintained its -0.1% target for short-term rates and that of 10-year bond yields around 0%, defying the global rate-hike wave.

SENTIMENT ON THE BACKFOOT

All three major US averages kicked off Thursday’s session on the backfoot, as optimism over buoyant earnings was offset by fears of the implications of aggressive monetary tightening on the growth momentum. Looking at earnings, telecoms multinational, AT&T’s results beat forecasts, but the company lowered its full-year free cash flow outlook. American Airlines’ earnings and revenue were in line with expectations, while United Airlines missed estimates. Meanwhile, Tesla rose nearly 4% following the electric-car maker’s positive earnings report on Wednesday, pushing other high-growth stocks into the green.

The UK’s FTSE 100 traded mostly flat on Thursday afternoon, as caution dominated market sentiment in Europe’s major bourses, and investors monitored the race for UK’s premiership and Russian gas volumes. Russian gas giant, Gazprom, resumed gas flows on Thursday through the newly restored Nord Stream 1. The company utilised 40% of the pipeline’s gas capacity, sending the same volumes as before the maintenance works started. Meanwhile, Conservative Party members voted for Foreign Secretary, Liz Truss, to take on former Chancellor of the Exchequer, Rishi Sunak, in the battle to become the UK’s next prime minister.

European stocks weakened on Thursday afternoon, as traders digested the ECB’s higher-than-expected rate hike. Meanwhile, Italian stocks fell sharply after Italian Prime Minister, Mario Draghi, was forced to resign, after his coalition abandoned him, sending the country to a snap election in Autumn. The DAX was 1% lower and the STOXX 600 inched down 0.2%.

South Africa’s JSE FTSE all share index traded 0.8% softer on Thursday, extending losses for the second session and tracking a fall in risk-appetite, amid renewed concerns of inflation. Losses were led largely by mining stocks with Anglo American, Kumba Iron Ore and Gold Fields all retreating over 4%.

GOLD GAINS SHORT-LIVED

Gold prices reversed early losses to trade around $1 700 an ounce on Thursday, assisted by a retreating dollar and a stronger euro, following the ECB’s rate hike. Still, gold hovers at lows not seen since March last year and is likely to remain under pressure. Stronger dollar fundamentals are holding as the Fed continues its tightening plans, making greenback-priced bullion more expensive for buyers holding other currencies.

Brent Crude futures fell by 4% to below $103 per barrel on Thursday, sliding for the second consecutive session. Crude is being weighed down by data pointing to weaker US gasoline demand, despite the peak summer driving season, and easing supply concerns. An International Energy Agency (IEA) report, released on Wednesday, showed US gasoline inventories rose by 3.5 million barrels last week, thumping expectations for a 71 000 barrel increase. Meanwhile, Libya’s National Oil Corporation announced crude production had resumed at several oilfields, after lifting the force majeure on oil exports last week. Oil prices have come under pressure since mid-June as mounting risks of a global recession, driven by aggressive monetary tightening, rattled commodity markets and overshadowed ongoing supply tightness.

Newcastle Coal Futures, the benchmark for top consuming region Asia, bottomed around $400 per tonne, easing from an almost record high of $430, as investors unwound some long positions on the back of prospects of increased supplies. China, the world’s largest coal consumer, announced that it could lift a nearly two-year ban on Australian coal, as tensions between the two countries ease and China seeks to replace shipments from Russia. Still, coal prices are poised to remain elevated amid robust demand and persistent global supply disruptions exacerbated by the war in Eastern Europe. Europe is now turning to seaborne coal from South Africa and even as far away as Australia, as it halts imports from Russia. India, the world’s second-biggest coal importer behind China, saw record thermal coal arrivals in June following recent power shortages.

DOLLAR RETREATS

The US Dollar Index reversed most of its gains to fall below the 107 mark on Thursday, after the ECB delivered its 50 basis point increase in interest rates. The euro soared almost 1% after the announcement, putting pressure on the greenback. Still, the US dollar is set to hold strong as risk sentiment remains fragile around the world, with the energy crisis in Europe and Italy’s political turmoil pressuring the common currency. More importantly, the Fed is set to continue its tightening plans and is expected to deliver a 75 basis point rate hike next week, a fourth straight increase, totalling 225 basis points year to date.

The euro traded near $1.02 on Thursday as investors digested the ECB’s interest rate hike. The common currency first appreciated almost 1% to a two-week high of $1.027 after the central bank raised its key interest rates but shed some gains after ECB President, Christine Lagarde, failed to provide investors with further details on the new anti-fragmentation tool and its interest rates. Lagarde said it will be the discretion of the central bank to make a country eligible for the new TPI, on the basis of criteria that are very specifically spelled out. Meanwhile, the political turmoil in Italy added additional pressure to the euro.

The British pound extended gains to an over one-week high of $1.202 as investors braced for an even more aggressive tightening from the BoE in response to the highest inflation rate in four decades. BoE Governor, Andrew Bailey, opened the door for a 50 basis point hike in August, which would be the largest since 1995, saying that the bank remains fully committed to bringing inflation down to the central bank’s target of 2%.

The South African rand strengthened slightly towards R17.00/$ after the South African Reserve Bank raised the key repo rate by more than expected, while signalling further aggressive monetary tightening ahead. In an attempt to tame the surging domestic inflation. The South African rand is still close to a 23-month low of R17.20/$, hit on 14 July, and has shed nearly 6.5% so far this year as the country battles with prolonged worker strikes and rolling blackouts, in addition to growing global recession fears.

The rand is trading at R17.05/$, R17.37/€, R20.39/£.