CLOUDY DAYS AHEAD FOR EUROPE
Europe entered 2022, crippled by the pandemic, but showing promise of a prolonged and robust phase of economic expansion, which was of course before Russia launched a full-scale war on Ukraine. Now, the promise of robust growth is a mere memory, and economic risks are lurking around every corner.
Key themes for this week include:
- European Union (EU) Spring Economic Forecast report paints a worrying picture
- United Kingdom (UK) growth positively surprises
- United States (US) Consumer Price Index (CPI) hits a fresh four-decade high
- Brent crude tests a sustained break below $97/barrel, while gold struggles at one-year lows
- Stocks subdued amid global growth fears
- South African rand treads water at 21-month low
EU SPRING REPORT CASTS SHADOW OVER EUROPE
The release of the Spring 2022 Economic Forecast by the European Commission is anything but rosy. It paints a sombre picture of the economic state and outlook for Europe and highlights the economic uncertainty that faces the region. The war in Ukraine has derailed any hopes of strong post-pandemic economic recovery. The report draws specific focus on the Russia-Ukraine war. The EU is the first of the advanced economy to feel the impact of Putin’s hostilities, due to 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 economic outlook for the EU 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 3.5% and 1.7%, respectively, as mentioned 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 abilities and subsequently lowering demand. The position households find themselves in is also worsened by the expectation that growth in compensation will lag inflation throughout 2022 and cause real household income to decrease by 2.8%.
While the Report, and the forecasts it contains, are highly dependent on various assumptions, it highlights the uncertainty that litters the economic environment, and the economic fallout the war has brought about. Now, with the war lingering, the report details the potential for further economic strain and adverse outcomes, such as:
- further increases in import prices could accelerate stagflationary forces brought about by the war. Greater than expected second-round effects could amplify them.
- Continued strong inflationary pressures could lead 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.
- A stronger-than-expected deceleration of economic activity in the US and China would further dent growth in the EU.
- COVID-19 remains a risk factor.
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; 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%, its 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.
South African retail sales increased by a mere 0.1% from a year earlier in May, following an upwardly revised 4.3% rise in the previous month and grossly undershooting market estimates of a 1.5% rise. The reading marks the smallest gain in retail activity since February, with consumers coming under heavy pressure from higher interest rates and inflation, notably for food and energy. Mining production in South Africa contracted by 7.8% year-on-year in May, after a downwardly revised 14.8% slump in the previous month. It marks the fourth consecutive month of a decline in mining activity, amid loadshedding and a three-month strike in the gold sector.
Taking a look at bonds, the yield on the South African 10-year bond neared 11%, its highest level since April 2020, as the perceived risk of the country increased following severe power cuts implemented by state-owned power utility, Eskom, which is having adverse effects on key economic activities. Additionally, policymakers from major global central banks reaffirmed their commitment to controlling inflation even at the risk of an economic downturn, fuelling uncertainty within South Africa’s economy.
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 rate 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 3%, 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 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 slurry 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, indicates fears of an impending recession, amid soaring inflation. On the earning 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 the 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.
The JSE FTSE All Share Index reversed early gains and was down 0.8% on Thursday afternoon, pressured by commodity-linked sectors and a dip in tech stocks.
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, these curbs are expected to 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, 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 $1.90, its lowest level in over two years, amid the broad rush to the safety of the dollar, on the back of higher-than-expected inflation readings. The pound has been declining since May 2021. On the political front, the UK’s ruling Conservative Party started its race to find its next leader and the future Prime Minister of the UK, with six candidates now in the running, including former Finance Minister Rishi Sunak.
The South African rand traded around R17.20/$, its lowest level since August 2020, as pressure from a stronger dollar mounted, amid expectations that the Fed will raise rates more aggressively and fears of a global recession. Meanwhile, the South African Reserve Bank is widely expected to raise its benchmark interest rate by 50 basis points to 5.25% next week, to curb quickening inflation. Risks of a recession and stagflation are looming for South Africa, amidst intensified loadshedding and a drop in commodity prices.
The rand is trading at R17.17/$, R17.20/€, R20.38.
