Weekly Update - Activity resists, inflation still spreading and central banks remain restrictive
Third-quarter figures show advanced economies are holding up (see Chart 1) despite the several headwinds that they are facing. Euro area GDP grew 0.2% quarter-on-quarter (2.1% year-on-year) and economic growth was positive in Germany (+0.3% qoq) and Italy (+0.5% qoq), both of which the consensus had projected to be in contraction during the quarter. GDP also grew in the United States, by 0.6% qoq. These better-than-expected figures on both sides of the Atlantic were driven by two factors: a continuing rise in household consumption, funded from surplus savings and strong labour markets, and resilient corporate investment. So far, the impact of rate hikes and the inflationary squeeze on purchasing power has mainly been restricted to the property investment component of demand, which is sharply down in the United States but also starting to shrink in Europe. While developed economies activity has resisted better than expected for now, the significant tightening of financing conditions and looming energy/geopolitical risks is likely to hit activity harder in the next few months.
Inflation figures show prices still trending strongly upward (see Chart 2). Euro area inflation jumped to 10.7% in October. Much of this was due to food and energy but the underlying component was also still rising, to 5%. Among the big zone economies, Italy and Germany now have double-digit headline inflation while France has one of the lowest rates in the region thanks to government measures (notably the ‘tariff shield’ on energy prices). In the United States, leading indicators suggest inflation will stay high.
In this context, central banks have continued to tighten policy and signalled further rate rises for upcoming meetings. The ECB raised policy rates by 75 bp for the second time running, taking its deposit rate to 1.5%. It also tweaked the TLTRO rules to incentivise early repayments and so drain some liquidity from the system. At the press conference, Ms Lagarde said she expected rates to keep rising and that discussion was now turning to reducing the ECB's sovereign and corporate debt holdings. The Federal Reserve also raised rates by 75 bp in early November, taking the upper bound to 4%, while continuing to reduce holdings of treasuries on its balance sheet by USD 60 bn per month. At the Fed press conference, Mr Powell said the speed of rate rises would likely slow at the next few meetings, the terminal rate would likely be higher than was forecast in September, and it was very premature to talk about a pause or pivot.
Given the risks to growth and still restrictive monetary policies, we maintain our defensive allocation.
Finally, in the main events of the week, we chose to talk about the brasilian presidential election and about the US labor market.