The euro recovers before the ECB meeting

Last Wednesday, the CPI (Customer Price Index) came out higher than expected in the US. The data published for June show that inflation is still accelerating at +9.1% and +1.3% on an annualised and monthly basis, respectively. The market had been expecting an annualised increase of +8.8%. One month earlier, prices had jumped +8.6% over one year and +1.0% over one month. This is the highest rate in more than four decades – since 1981, to be exact. High inflation is affecting all sectors, especially housing, energy and food. Commodity prices also continue to rise, but at a slower annual rate than last month. If we look for a break in the clouds, that might suggest that the peak has passed. With the release of the CPI figures, the dollar appreciated but did not immediately manage to break the parity against the euro. It was not until the next day that the euro fell below $1 in a move triggered by the unexpected announcement that Italian Prime Minister Mario Draghi would resign after the 5-Star Movement refused to back him in a confidence vote. With that, the single currency hit a twenty-year low of 0.9952. At the same time, after having considered the possibility 50 and then 75–basis point hikes, the market began to seriously consider a historic 100–basis point increase at the next Fed meeting on 27 July. An increase of this magnitude would be the largest rate increase since the 1990s. However, this scenario became less likely after comments from some Federal Reserve officials who sought to temper expectations. The consensus is now that the Fed will increase rates by 75 basis points by the end of the month.

In any case, this week the news is mainly focused on the Old Continent. The European Central Bank is holding its monetary policy meeting tomorrow (Thursday 21st) and, after ending debt purchases, it is now set to raise its key interest rate for the first time in eleven years. The change comes as countries of the eurozone are facing unbridled inflation like elsewhere the world. Price increases in the eurozone last month broke a new record at an annualised rate of 8.6%. And as inflation has soared, confidence has plummeted. The ZEW, the German economic sentiment indicator, has plunged to its lowest level since 2008. In addition to this explosive situation, Europe is facing other crises. To begin with, a political crisis in England, with the (forced) resignation of Prime Minister Boris Johnson and in Italy with the (refused) resignation of Prime Minister Mario Draghi. In England this morning there are only three candidates left in the race for the presidency of the ruling party and tonight we will know the finalists. It is the Conservative MPs who are voting amongst themselves The future Prime Minister should be appointed in the autumn. In Italy, Mario Draghi is due to address parliament later today, as requested by the Italian president when he refused Mr Draghi’s resignation. Political uncertainty and instability have of course weighed on the euro. In addition, there is the war on Europe’s doorstep and the energy supply problems it has brought. However, since 14 July and its low of 0.9952, the euro has started to rise again. There are several reasons for this: firstly, it seems that the ECB, which had previously planned a 25–basis point hike, is now considering raising rates by half a point due to inflationary pressures. In order to avoid a surge in financing costs for “peripheral” countries, ECB officials are also working on an agreement to avoid yield fragmentation. On the energy front, Russia announced that gas deliveries via the Nord Stream 1 pipeline would resume tomorrow after a 10-day maintenance shutdown. The volume of gas delivered will be less than expected, but it was feared that Vladimir Putin would use the pretext of a technical failure to stop gas deliveries altogether and thus put pressure on the European countries.

In China, GDP contracted more than expected in the second quarter, falling by 2.6% against an estimate of -1.4%. The country’s zero-COVID policy is to blame. Over a year, growth is only +0.4% against +1.0% expected and +4.8% in the first quarter. However, the other economic statistics for June including the rise in industrial production and the rise in retail sales and exports give hope for a future upturn. In England, where inflation is running at 9.1% year-on-year, Michael Saunders, a member of the Bank of England, said he was in favour of further rate rises to 2% or more by 2023. The rate is currently 1.25%. Lastly, oil is back above $100 a barrel. President Joe Biden travelled to the Middle East to renew dialogue with Saudi Arabia and try to convince it to open the floodgates further. Bringing gasoline prices down would have been a big help a few months before the mid-term elections, but the President Biden left without having made any significant progress.