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Inflation heats up in Eurozone

Edward Bell - Senior Director, Market Economics
Published Date: 01 August 2022

 

  • Inflation in the Eurozone accelerated in July to 8.9% y/y, up from 8.6% a month earlier. Core inflation also picked up, rising by 4% last month compared with 3.7% in June. The wide gap between core and headline inflation shows how the surge in energy prices in particular are contributing to higher costs for consumers and firms. Following the announcement of a further reduction in flows of natural gas from Russia to Germany, energy costs will remain a main driver of higher prices over the rest of the summer. The ECB has already begun to respond to high inflation, hiking rates by 50bps at the July meeting, and will likely continue to hike rates when it meets again in September.
  • Following the weaker than expected US GDP numbers for Q2, data from the Eurozone economy actually came in better than expected. France’s economy expanded by 4.2% y/y in Q2, compared with market expectations of growth at 3.7%, while Germany’s economy grew by 4.6% y/y, also beating projections of 3.7%. While the annual numbers are positive, Germany’s economy still slowed down in Q2 with the quarterly rate of growth dipping to 0% from an upward revised 0.8% for Q1. For the Eurozone on aggregate, GDP expanded by 0.7% q/q in Q2
  • Turkey’s trade deficit hit USD 8.2bn in June, down slightly from almost USD 11bn a month earlier. For the first half of the year, the trade deficit has totalled USD 51.4bn, up from USD 21bn in the first half of 2021. Like many economies, Turkey has faced rising costs for commodity imports, particularly food and energy that have been pushed higher by the war in Ukraine. Energy costs were a principal driver of higher imports last month, up by 122%.
  • Personal spending in the US was essentially flat in June as a sharp rise in petrol prices cancelled out a 1.1% increase in nominal spending. While growth was negligible it was an improvement from a downward revised fall of 0.3% recorded for May. The PCE deflator, the Fed’s actual inflation target, rose by 1% m/m and was up by 6.8% y/y, more than three times the target 2% level. While data from the US is showing a sustained downward move—not least of which was the second quarterly contraction in GDP for Q2—the inflation dynamics remain poor and will keep the Fed on a hawkish footing with further rate hikes expected in the rest of 2022.
  • Official PMI numbers from China show the economy slowed in July as the country’s stringent approach to Covid-19 throttles growth. The manufacturing PMI dropped to 49 in July, down from 50.2 a month earlier. The non-manufacturing indicator held up relatively better, slipping to 53.8 from 54.7. The private sector Caixin PMI dropped in July as well, falling to 50.4 from 51.7 on the manufacturing index, well below market expectations. The persistence of the Covid-0 policy in China remains a negative for global growth, as highlighted by the IMF in their latest World Economic Outlook.
  • Net foreign assets held at Saudi Arabia's central bank rose USD 13bn in June to reach USD 448.8bn, the highest level since December 2020 and the biggest monthly increase since November 2021.  Higher oil prices and increased oil production have contributed to a budget surplus this year, although this had not been reflected in rising net foreign assets at SAMA until June.  Broad money supply growth accelerated to 8.9% y/y in June from 7.8% y/y in May, and private sector credit growth also picked up to 14.1% y/y from 13.9% in May. 
  • Saudi Arabia's economy grew 11.8% in Q2 according to flash estimates, driven mainly by a 23.1% expansion in the hydrocarbons sector. Non-oil sector growth accelerated to 5.4% y/y in Q2. 

Today’s Economic Data and events

  • 09:00 IN manufacturing PMI July
  • 12:00 EC manufacturing PMI July (f): forecast 49.6
  • 18:00 US ISM manufacturing July: forecast 52.1

Fixed Income

  • Government bonds rallied last week as data took a decidedly negative turn, with a second quarter of economic contraction in the US pushing back against a Federal Reserve committed to fighting inflation. Yields dropped on US Treasuries with the 2yr UST yield down almost 9bps over the week to 2.8844% while the 10yr UST yield fell by 10bps to 2.6487%.
  • In European markets, the 2yr schatz yield closed lower by 14bps over the week at 0.264% while the 10yr bund fell by 21bps to 0.814%. That gains in the bund market come even as European inflation remains very hot, rising to nearly 9% in July. In the UK, 2yr gilt yield closed lower by 13bps to 1.696% and the 10yr was down almost 8bps at 1.861%.
  • In central banks this week, the RBA sets policy on August 2nd with a 50bps hike expected. The Bank of England meets on August 4th and we expect they will need to hike by 50bps, faster than their pace so far given the hot inflation picture in the UK. The RBI is also due to set policy later this week with a 50bps hike expected by the market.

FX

  • The dollar fell a second week running as markets price out aggressive hike expectations. The broad DXY index fell by 0.77% to 105.903, its weakest level since the start of July. However, the gains for currencies were mixed with EURUSD holding flat over the week at 1.022 as some wide intraday swings in response to the Fed’s 75bps hike seemed to cancel each other out. GBPUSD had a much more unequivocal response, rising by 1.4% last week to 1.2171 while USDJPY dropped by 2%, the strongest weekly gain for the Yen since March 2020.
  • Commodity currencies rallied strongly with CAD leading the pack. USDCAD fell by 0.9% to 1.2795 last week while AUDUSD gained 0.8% to 0.6985 ahead of this week’s RBA meeting. NZDUSD rose by 0.2% to 0.6278.

Equities

  • Equity markets closed out July on a strong footing as anxiety over hawkish central banks faded somewhat with the S&P 500 up more than 9% in July, its strongest monthly gain since markets pulled higher in April 2020 in response to Covid support. The S&P rallied 4.3% last week while the Dow added about 3% and the NASDAQ gained 4.7%. In European markets the FTSE rallied by 2% while the EuroStoxx added a bit more than 3% to end the week.
  • Asian markets were more downbeat, however, with the Nikkei ending the week down 0.4% and the Hang Seng falling by 2.2%.

Commodities

  • Oil prices bounced higher last week but the gains failed to prevent both Brent and WTI recording a second monthly loss in a row. Brent futures settled at USD 110.01/b, down 4.2% on the month, while WTI dropped by 6.8% to USD 98.62/b. This week OPEC+ will be in focus and what strategy the producers’ alliance will take from September onward. The Russian and Saudi energy ministers met at the end of last week with a pledge to be “firmly committed to the goal of the OPEC+ agreement on preserving market stability” which may be a signal that markets shouldn’t expect a radical change in policy. Few members within OPEC+ have the freedom of maneuver to increase output easily and an increase in Saudi production targets, in response to requests from the US for instance, could threaten the viability of the whole OPEC+ enterprise.

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