Inflation remains high and above mandated levels, but if recent communication is anything to go by, it seems as though Western central banks, primarily the European Central Bank (ECB) and the Federal Reserve (Fed), have reached the peak of their respective hiking cycle. This comes after several months of significant hikes that began in March 2022 when the Fed began hiking rates. However, despite recent discourse that rates have peaked or are close to peaking, financial data across economies indicate that perhaps there is scope for rates to rise further.
American consumers’ spending power remains strong due to the robust labour market. In fact, core retail sales data for August showed growth of 0.1%, which is lower than July’s growth of 0.7% but came in better than expected. Consumer spending is expected to remain resilient despite the recent easing in the labour market as household balance sheets are still showing signs of strength.
US macroeconomic indicators put at risk the widely held expectations of an upcoming slowdown, with the Atlanta Fed tracking 4.9% real GDP growth in the third quarter. Furthermore, the Fed’s preferred measure for inflation, namely core inflation, complicates the picture as to whether more rate hikes are required. Core inflation was 4.3% in August, which is lower than the prior month’s 4.7%, but still substantially higher than the Fed’s mandated target of 2%.
Last week, the ECB hiked rates for a 10th consecutive time when it announced a 25-basis-points hike. However, the ECB signalled that it has likely reached “sufficiently restrictive” policy rates. The ECB’s messaging during the meeting was perceived to be dovish despite the rate hike, as the messaging delivered alluded to the fact that the hiking cycle may be over. Therefore, the market’s focus will now shift towards the duration for which the ECB will keep policy rates at their peak before ultimately lowering them to less restrictive levels.
The current macroeconomic situation in Europe is different from the one in the US. While inflation remains high in Europe, economic growth in the euro area is weaker than the US as the ECB, as per its latest projection, expects economic growth of 0.7% this year, which was revised downwards by 0.2% from the prior projection.
US macroeconomic indicators put at risk the widely held expectations of an upcoming slowdown- Simon Gauci Borda
Given the higher energy prices, headline inflation forecasts have been revised higher to 5.6% and 3.2% for 2023 and 2024 respectively. All in all, contrary to the US, the ECB’s forecasts paint a picture of increasing economic headwinds for the bloc.
The weaker macroeconomic backdrop in Europe is also being driven by the slowdown in the Chinese economy, since European exports, primarily from Germany, are reliant on Chinese consumer demand. Recent figures released show that the manufacturing sector in China is weakening while the property development sector, which contributes significantly to the Chinese economy, has been in decline, as manifested with the bankruptcy of Evergrande and Country Garden, among others.
The debate on whether peak rates have been reached has been further complicated by the recent rise in the price of oil and its effects on inflation. Since mid-June, the oil price has risen circa 32%. Oil inventories remain tight and are expected to tighten further as both OPEC+ and non-OPEC+ producers decrease production.
Whether central banks will raise rates further from current levels is still up for debate as there are several factors that may alter the path of monetary policy from current expectations. However, it seems as though rates may have to remain elevated for some time to tame the high levels of inflation before less restrictive measures are taken.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.
Simon Gauci Borda is a research analyst at Curmi and Partners Ltd.