Euro: the end of negative rates

As expected, the European Central Bank raised rates last week. There was some uncertainty as to how big the rate hike would be: a quarter, or half a point? In the end, it was half a percentage point. This is the ECB’s first act aimed at countering inflation in the eurozone, which hit 8.6% in June – its highest level ever. The ECB will raise interest rates until inflation falls below its 2% target, said its president Christine Lagarde. Thus ends the era of negative rates, with the deposit facility rate back at 0%. In addition to the rate hike – and as the German-Italian spread soared following the resignation of Mario Draghi in Italy – the ECB has set up a new emergency programme to protect the most indebted countries in the area. Still, it is not clear skies ahead. Gas and oil prices are on the rise after Russian gas giant Gazprom announced a drastic reduction in gas deliveries to Europe to 20% of capacity for another year due to maintenance. On the statistical side, the IFO index, which reflects German business confidence, reached its lowest level since June 2020. It stands at 88.6 points, down 3.6 from 92.2 in June. The consensus had been 90.2. Here too, rising energy prices and fears of a gas shortage are weighing on the business climate in Germany, Europe’s largest economy. In the immediate term, the ECB’s decision and the strong rhetoric that accompanied it has allowed the single currency to recover and move away from parity against the dollar. Such a recovery, however, did not materialise against the Swiss franc. The franc continues to benefit from better economic fundamentals compared to the eurozone. These include lower inflation, more dynamic growth, low unemployment and the fact that the SNB no longer considers our currency to be overvalued. As a result, the EUR/CHF exchange rate has not returned to parity – rather, it has instead continued to fall.

All eyes are now on the Fed, which is finishing a two-day meeting today. A poll showed that 80% believe that the Federal Reserve will massively raise rate again with a 75-point hike. The other 20% are even expecting a 100-point increase. The Fed Funds rate is currently set in a range of 1.50% to 1.75% and futures are forecasting a median level of 2.55% for September and 3.35% for December, corroborating market expectations of significant increases in the cost of money. Jerome Powell will mainly have to answer questions about the recession fears that come with these rate hikes. His response is eagerly awaited.

In the UK the concerns about inflation are the same or even greater than in the US or Europe. The cost of living is increasingly higher. Consumer prices rose by 9.4% on an annual basis in June, a new 40-year high. By May, inflation had risen to 9.1% and the Bank of England estimates that prices could rise by up to 11% by the end of the year. The market is now expecting a 0.50% hike at next week’s monetary policy meeting. The race to succeed Boris Johnson continues with only two candidates remaining. Rishi Sunak, former Chancellor of the Exchequer, and Liz Truss, Secretary of State for Foreign Affairs. Sunak is seen as the continuity candidate, while with Truss, rates would be more likely to rise quickly according to a Bloomberg poll. Truss’ economic plan promises immediate tax cuts, a measure that would certainly stimulate the economy but would also boost inflation. Rishi Sunak is also in favour of lowering taxes but later when the situation has stabilised, probably not before autumn 2023 according to the same survey.

Russia’s central bank surprised the market by lowering its key interest rate from 9.5% to 8% on Friday, which is lower than it was before the war in Ukraine began. The good performance of the rouble and the fall in inflation have allowed the CBR to proceed with this reduction, clearly intended to support an economy damaged by Western sanctions. Nevertheless, the IMF has revised its forecast for Russia’s GDP upwards. It estimates that the decline in growth will be less severe than expected and should be around -6% compared to a decline of over 8% previously.

The price of gold has suffered significantly in 2022, with the price falling by around 20% from a peak of $2,070.44 per ounce on 8 March. The main driver of gold’s current decline is the wave of near-universal monetary tightening by central banks. The rise in yields is obviously not providing an incentive to take refuge in the yellow metal, which does not yield anything. As this movement looks set to continue, at least into 2022, one wonders what might come to the rescue of gold. A recession, if it were to materialise, would possibly be a catalyst for a reversal of the trend. A slowdown would cause the Fed to reduce or suspend its monetary tightening, which would certainly lead to a decline in the dollar. Gold made a double top above $2,000 an ounce and then broke a bullish trend line that had been in place since 2019. The price is now testing the major support at $1,700 formed by the 2021 lows. If the level were to give way, this would open the way for a potential fall to the 2020 lows of around $1,450 per ounce.