Central banks are walking a tightrope. The rather different situations on both sides of the Atlantic illustrate this. In July, the Fed remained determined to combat inflation, which remains at record levels. Expected to reach 9.2% in July, it reached 9.1% in June. The only glimmer of hope is that the rise in the price of oil has paused (with a drop from 120 to 100 dollars a barrel for WTI), and that the peak of inflation therefore seems to be near.
Fed raises rates at a steady pace
At its last meeting on 27 July, the Fed raised the key rate by a further 75 basis points (bps), to arrive already in a range of 2.25% – 2.50%. This corresponds to the maximum level of the last tightening period after the financial crisis of 2007/8, reached in 2019, before the Covid-19 pandemic broke out. The committee plans to increase it again by the same amount next month. The US central bank believes that these measures should remain neutral in terms of economic growth. And yet, for the second quarter in a row, US GDP has fallen, even more sharply than expected, at an annualised -0.9% between April and June. Among other things, private investment fell. Fears of a US recession are growing. Nevertheless, the labour market remains tight.
GDP growth in Europe
In Europe, GDP data was reassuring. Second-quarter growth in the euro area beat estimates, accelerating to 0.7%, half a percentage point higher than expected. The post-pandemic recovery, especially in tourism after the lifting of health measures, supported the momentum.
On the consumption side, the situation is much more subdued. In July, inflation is expected to have risen by a further 30 bp to 8.9%. Gas prices have risen again. Despite a resumption of deliveries at reduced speed through the Nord Stream 1 pipeline, the supply of Russian gas needed for the winter in Europe is by no means certain. And while oil prices have somewhat abated, the loss in value of the euro against the US dollar is limiting any positive effects.
ECB in a difficult situation
The ECB has finally acted by raising its key rate by 50 bp, more than previously announced. But given the pace set by the Fed, this was not enough to reverse the trend. Especially since a feeling of weakness still prevails. Towards the end of the month, bond investors made it clear that they did not believe in the measures put in place to contain the yield spread between German Bunds and Italian government bonds. And the premature end of the Draghi era as prime minister did not help. The yield differential between the two sovereign debts was briefly even higher than before the ECB announced that it would develop a plan to avoid a repeat of the 2012 debt crisis scenario.
The question is whether Christine Lagarde will be able to make the necessary hike to turn the tide of inflation by supporting the euro, without causing a debt crisis or recession. Given the rise in the US dollar, traders do not seem to be convinced. What if the better financial situation in the North of Europe is due to underinvestment in liquefied natural gas infrastructure, as well as in storage facilities, since Russian gas brought in through pipelines is cheaper? In any case, this question from politicians in the South underlines the fact that energy plays a key role in Europe’s economic situation. It could even reshuffle the deck between North and South. The absence of a coherent common energy policy is undoubtedly weakening the entire euro zone.
Purchasing managers more pessimistic
Despite the negative first half of the year for US GDP, purchasing managers remain in a growth zone on the manufacturing side. In July, however, the S&P Global US PMI showed the weakest growth for two years, at 52.3 points. On the services side, however, the score fell to 47 points (compared to the expected 52.6 points), below the 50-point mark. With pressure on production capacity easing, the pace of new job creation has also slowed. In the Eurozone, pessimism took over in the manufacturing PMI, with a drop from 52.1 to 49 points. The index had not fallen below 50 points for 26 months. The majority of companies are planning to decrease their production next year, rather than increase it. The services PMI was just able to stay in the positive zone, at 50.6 points (compared to 53 points in June). Tourism struggles to offset declines, particularly in the finance sector.
