European stocks finished yesterday very much on the back foot after the OECD followed up yesterday’s World Bank global growth downgrade, with one of its own.
The OECD said the global economy would pay a heavy price for Russia’s invasion of Ukraine, with much weaker growth and higher prices, which is likely to result in permanently higher inflation, and a weaker recovery.
The OECD painted a grim outlook of low growth and higher for longer inflation levels.
US markets also underwent a similarly negative session for the same reasons, a trend that has continued this morning in Asia, and look set to translate into a lower European open.
The latest China trade numbers for May indicated a decent recovery in imports and exports, after both stalled in April when the Chinese economy ground to a halt because of lockdowns and covid restrictions.
Imports in May rose by 4.1%, a modest improvement on April’s 0%. Exports were also better, rising 16.9%, a strong improvement on the 3.9% gain seen in April.
Today’s focus will be on the ECB rate decision which is due to 12:45BST, followed by the press conference at 13:30BST, and although no change in policy is expected it is expected that ECB President Lagarde will use her time to tee the markets up for a policy move next month.
Yet another central bank that is way behind the curve when it comes to inflation, it was only at the end of last year that ECB President Christine Lagarde said that a rate hike this year was unlikely, even as CPI prices rose to 4.9, and were already at 6% in Germany.
As an exercise in denial its up there with Fed chair Jay Powell who was insisting at around the same time that perhaps the word “transitory” should be retired from the financial lexicon when describing what was happening with inflation, yet only ended the Fed’s bond buying program in March this year.
That alone should have tipped off the ECB that inflation was only likely to go one way, with down not being an option. Lagarde went on to claim that we were probably at the peak of the inflation hump and that it would start to decline into 2022.
Even without the benefit of hindsight the complacency in that statement was delusional, especially given how PPI was trending, and continues to trend, and while the Ukraine invasion can’t have been foreseen, it was still obvious that inflationary pressures were building across the bloc.
Fast forwarding six months and the ECB is now having to contend with CPI of 8.1%, while in Spain CPI is at 8.5%, and in Germany its even higher at 8.7% and at its highest since the early 1990s. That’s still low compared to levels in places like Estonia where its 18.8%, and 16.8% in Lithuania, however the calculus now appears to be shifting towards discussion of a 50bps rate move in July, and not 25bps which is what is currently priced.
Even with the current direction of travel a 50bps move in July still seems a big ask even at this stage but it would be foolish to rule it out completely.
The current situation presents a huge problem for the ECB, and its credibility, because if they signal a more aggressive tightening path, bond spreads in countries like Italy may start to rise to levels that are hugely problematic for debt funding purposes.
This is the tightrope the ECB must navigate and while the central bank will talk about the implementation of other tools to control spreads between German and Italian yields the truth is that the gap between the two is 50bps wider than it was in March.
At her first press conference Lagarde didn’t get off to a great start when she said that the ECB wasn’t there to close spreads, a comment that was quickly corrected. The next few months will pose enormous challenges for the ECB to do exactly that, as they embark on a possible rate hiking cycle.
The fact is that even if the ECB were to hike rates to back above 0%, the effect is likely to be negligible at best. Real rates are still deeply negative and are likely to remain so for months, while its ability to control spreads is constrained by the capital key.
The best we can hope for is if the ECB is able to put a floor under the euro to prevent further declines against the US dollar and hope that inflation comes down on its own.
Today’s meeting will also give President Lagarde the opportunity to lay out what to expect next month and the rest of the quarter when it comes to a move in the headline rate, along with the new economic projections for inflation and GDP, with inflation unlikely to fall back to target before 2024.
EUR/USD – currently respecting downtrend line resistance from the highs this year now at 1.0750. Downward pressure remains intact while below 1.0760, with a move through there arguing for 1.0850. Support currently at 1.0640, with a move below targeting 1.0530.
GBP/USD – the 1.2600 area continues to be a barrier to further gains. We need to break above the 1.2630 area to open up the 1.2820 level. A sustained break below 1.2450 argues for a move towards 1.2320.
EUR/GBP – finding support at trend line from the April lows with resistance at the 0.8600 area currently capping the upside. A move below 0.8470 retargets the 0.8420 area.
USD/JPY – on course for a move towards the 2002 peaks at 135.00. Only a move below the 50-day MA at 128.00 undermines upward momentum and argues for a move lower towards the 123.00 area.
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