Inflation is surging everywhere. It is one of the biggest headaches that central banks are facing, and the latest talk on the street among both producers and consumers. The Russian invasion of Ukraine has only magnified the inflationary pressures, which have been building for quite a while.
Supply chain disruptions driven by the pandemic, pent-up demand by consumers and the unprecedented policies implemented by central banks, together with the Ukraine war, are the main drivers behind the surge in inflation. The latest ECB projections issued in March 2022 forecast European average inflation to be 5.1 per cent in 2022, particularly due to the significant oil, gas and soft commodities’ price pressures caused by the Ukraine war.
Locally, the latest inflation numbers published in February stood at 4.2 per cent, marginally up from 4.1 per cent in January. However, these figures do not fully capture the effects of the Ukraine war.
Beside the inflationary pressures that the war presented, it also dampened the near-term economic outlook and triggered a global risk-off in the markets. The sharp increase in energy prices and the negative consumer sentiment are the main factors behind this. Most analysts are still forecasting the European economy to grow, albeit at a slower pace than previously anticipated. These pressures will also be felt on our shores and challenge locally listed companies.
Inflation has heightened concerns of a more aggressive monetary policy response from the European Central Bank. The Governing Council’s last meeting in April reiterated its stance that the asset purchasing programme will be concluded in Q3, 2022, and key interest rates will be adjusted sometime after the end of the purchasing programme. However, the primary and immediate concern for companies and consumers, including locally, is that rising prices are squeezing purchasing power.
Several locally listed companies have started to publish their 2021 financial results, and the initial results are encouraging- Stephen Sammut
The initial reaction of both the local equity and corporate bond markets was relatively muted following the Russian invasion. Although the uncertainty on how the geopolitical crisis will pan out and how the different outcomes of the war and the sanctions imposed might affect the local economy, the pre-war momentum of business activity recorded was above long-term average.
The labour market also remains very supportive and the number of registered unemployed is now below pre-pandemic levels. In addition, the COVID-19 headwind seems to be ending with tourism gradually returning to our shores and most restrictions no longer in place or drastically eased. Locally, authorities have vowed to remain supportive, which should act as a shield to consumers from the rise in energy prices.
Several locally listed companies have started to publish their 2021 financial results, and the initial results are encouraging. Most companies have reported a material improvement compared to 2020, which was severely impacted by the pandemic. Companies operating in the financial sector have all registered profitable results with dividends returning to the fray.
In addition, the rise in yields driven by the increasingly likely hike in interest rates should significantly improve the profitability of banks in 2022. On the other hand, banks were cautious on the impact that the Russia-Ukraine war might have on the economic outlook, and inherently on their bottom-line profits.
Other locally listed companies, including property and travel and leisure companies, have also registered an improvement in their profitability, albeit still below pre-pandemic levels as the gradual return of tourism, easing of COVID-19 restrictions, and an increase in consumer confidence all contributed positively.
Most companies were optimistic on the outlook for 2022; however, a cautious tone was set as cost-push inflation, which is inflation driven by the cost of raw materials, will have a significant impact on companies’ operations. Additionally, companies were uncertain on how consumers will react given that their purchasing power will be affected by the increase in their daily cost of living, hence affecting the amount of money they can spend on luxury goods.
Inherently, should the companies’ costs increase significantly, and consumers reduce their expenditure because of weaker purchasing power, the profitability of companies will be negatively affected.
Despite the significant challenges that local companies are facing this year, most of these companies have strong balance sheets, which will help them face these challenges. It is inevitable that companies’ profitability will be challenged by the sustained high energy price environment and import costs, however this is likely to be limited.
Undoubtedly, Malta Government Stocks (MGS) will be the most impacted local asset class because of inflationary pressures, a potential ECB rate hike, and the uncertainty that the Russia-Ukraine war presents. During the start of the war up to mid-February 2022, yields on the MGS fell as investors fled to safer assets. However, as the situation evolved and the inflationary pressures were magnified by the sanctions imposed on Russia, yields started to pick up again, resulting in lower MGS prices.
The trajectory of the MGS market will very much depend on the inflation figures and central bank’s tightening of monetary policy.
The Russian invasion of Ukraine has dampened the economic outlook and magnified inflationary pressures. Local companies are still optimistic for 2022, however, a more thoughtful tone is being set as the rise in the cost of living could dampen investor sentiment.
Lastly, it is important to point out that locally listed companies do not have material direct exposures to Russia, inherently meaning that the risks are of an indirect nature.
Stephen Sammut is portfolio manager at BOV Asset Management Ltd.
The author and Bank of Valletta have obtained the information contained in this article from sources they believe to be reliable but they have not independently verified the information contained herein and therefore its accuracy cannot be guaranteed.
The author and the bank make no guarantees, representations or warranties and accept no responsibility or liability as to the accuracy or completeness of the information contained in this document. They have no obligation to update, modify or amend the article or to otherwise notify a reader thereof in the event that any matter stated therein, or any opinion, projection, forecast or estimate set for the herein changes or subsequently becomes inaccurate.
BOV Asset Management Ltd is licensed to conduct investment services in Malta by the Malta Financial Services Authority.