Weekly Update - Confirmed hawkish turn for DM Central banks
A new environment with less growth and more inflation. Before the Ukraine war shock, developed economies were looking at a scenario of robust growth and high inflation (near 8% in the United States, near 6% in the Euro area). Central banks were stating their willingness to move monetary policy back to normal, starting this year, to head off the risk of a wage-price spiral and prevent an un-anchoring of inflation expectations. The Ukrainian-Russian conflict has now cast many uncertainties into this picture, likely weighting on growth and giving inflation an extra boost. The OECD, for instance, estimates the shock will knock 1 point off GDP growth and push inflation up 2 points. Central banks in the United States and Europe have responded in similar ways, clearly communicating their willingness to continue normalising policy. However, the economy looks very different either side of the Atlantic.
In the United States, a “strong economy and extremely tight labour market” has led the Federal Reserve to hike its policy rate by a quarter point and signal a further 1.5-point rise by year end. Household consumption is still growing fast (chart 1), explaining much of the inflation, notably the price of goods. Salaries are tracking a parallel path (chart 2), in a highly dynamic jobs market. While the shock of the Ukraine war will dampen activity, the United States should be less affected than Europe because of their lesser financial and commercial links with Russia, particularly when it comes to energy.
In the Euro area, the less favourable economic environment has not stopped the European Central Bank (ECB) announcing it wants to start normalising policy in coming months. The economy remains slightly below pre-COVID levels and seems more sensitive to the negative spillovers of the Ukraine war. The OECD expects it to feel twice the impact of the United States (-1.5 points off growth in the Euro area against -0.75 points in the United States). Inflation was already largely accounted for by the negative shock from energy price rises and the Ukraine war should only reinforce this trend. Finally, labour markets as a whole show no signs of wage pressures, alleviating fears of second-round effects. While the ECB may persist with its determination to normalise, its policy tightening is nonetheless likely to be smaller in scale.
Despite the expected slowdown and deep economic uncertainty triggered by the Ukraine war, central banks in developed countries will continue returning their policies to normal, by halting the expansion of their balance sheets and raising policy rates in the course of the next few quarters. In light of which, we maintain our Neutral stance on equities and Underweight bonds.
Also, in the main events of the week, we chose to talk about nickel trading and oil prices.