Three minutes to understand the issues around inflation.
Inflation data for July and August signaled the start of a slowdown in headline inflation and core inflation in the United States and Canada, but continued acceleration in the rest of the G7. Asia, which for a long time seemed to escape the inflationary wave, experienced an acceleration in consumer prices in the summer, driven by food prices and energy prices. The peak of inflation is still far from being reached in Europe, in particular because of energy prices which hit new records this summer. Even if the European Union’s gas storage objectives (to reach 80% of capacity by November 1, 2022) are reached several weeks in advance, the threat of a total stoppage of Russian supplies continues to maintain upward pressure on the costs. This is reflected in wholesale electricity prices, which have exceeded €500/MWh on the European market, ie more than 10 times their average historical level. Competition for the supply of liquefied natural gas between Asia and Europe has led to higher gas and electricity prices in Asia and, to a lesser extent, in the United States. The 12-month futures on the gas and electricity markets have reached record levels, which reflects the risk that this energy shock will persist for a long time. The prices of metals, oil, fertilizers or foodstuffs are falling following the peak reached in the spring of 2022 but nevertheless remain at very high levels.
CONSEQUENTLY, WHAT ARE THE MARKET EXPECTATIONS AND CENTRAL BANKS’ REACTIONS?
Over the summer, the inversion of the US yield curve deepened, with the spread between 2-year and 10-year rates reaching -50bp. Market expectations on Fed funds point to a rise in key rates until early 2023, then a stabilization in the first half, before a drop caused by a recession. The prevailing sentiment is that higher rates and high inflation will degrade growth and the labor market and cause the Fed to quickly halt monetary policy tightening. However, the members of the Fed have hammered during the summer their determination to fight once morest high inflation, even if it means causing a recession, and have denied a movement of pause in the monetary tightening intervening so early. They believe that the decline in inflation will have to be permanently established for the break to occur. Jerome Powell recalled, during the Jackson Hole symposium at the end of August, this determination to act until “the job is done”.
In Europe, the ECB carried out its first rate hike since 2011, bringing its deposit rate to 0 at the end of July. Isabel Schnabel’s speech at the central bankers’ conference at the end of August also affirmed the ECB’s determination to continue its move to raise key rates as inflation reached 9.1% in August 2022 in the euro zone. . François Villeroy de Galhau, the Governor of the Banque de France, mentioned the achievement of the neutral rate around 1.5% before the end of the year.
China, for its part, experienced a sharp slowdown in activity in the summer with the closure of factories and ports linked to the Covid, energy shortages due to exceptional heat waves and still the difficulties of the real estate sector. In this context, the authorities announced a budgetary support plan and the PBOC carried out several surprise rate cuts once morest the trend of most central banks.
WE BEGIN TO SEE A SLOWDOWN IN DEMAND, WHAT SHOULD WE FEAR NEXT?
The business tendency surveys for July and August point to a slowdown in the economy everywhere in the world, even if this is less marked in services than in industry. The “new orders” component shows a slowdown in demand and inventories of finished products are reaching high levels close to the known post-crisis peaks of 2008. Tensions on supplies and on input prices are less marked. After a favorable summer for spending on services, we will have to monitor the trend in demand and inventory levels. They might signal a turnaround in the economy and negatively impact company margins, which remain at high levels for the time being. Visibility on the evolution of the economy appears particularly limited at the start of the 2022 school year, unlike the determination of central banks to fulfill their mandate. Finally, the start of the new school year is accompanied by a busy political calendar: in Europe, with a new Prime Minister in the United Kingdom and general elections in Italy on September 25, in the United States with the mid-term elections and in China with the holding of the 20th Congress of the Chinese Communist Party in mid-October.