Inflation, central bank measures to combat it and the danger of a recession are always the three elements that dominate assessments of the macroeconomic situation. The wrong weighting of these factors can even lead to the downfall of a government, as the case of former Prime Minister Liz Truss in the UK has shown.
In his speech on the occasion of the last monetary policy decision in early November, Fed Chairman Jerome Powell showed his determination to pursue an unpopular line. He is prepared to raise rates above the market’s expectations to fight inflation, even at the cost of causing a recession. Therefore, the expected easing after another unsurprising 75 basis point (bp) hike to 3.75%-4% is unlikely to happen. The US dollar has resumed its upward movement. Against the euro, it is solidly above parity. The yield on 10-year Treasuries has resumed its upward movement, reaching 4.16% in early November.
However, at the end of October, Christine Lagarde of the ECB also raised interest rates by 75 bp, in line with consensus expectations. That, however, did not allow the single currency to reverse the trend against the dollar. The next ECB monetary policy meeting is not scheduled until mid-December.
Eurozzone inflation at a new record high
The problem remains the same: despite having crossed the neutral zone toward tightening, inflation in the euro area is not about to calm down. In October, it even reached a new record high of 10.7%. In the United States, in September, the increase was only 8.2%.
The price of energy, with the war in Ukraine continuing, and of food are still the driving forces behind this record increase in the euro zone. The effect of the lull in gas prices was more than offset by the rise in the price of a barrel of crude oil of around 10 dollars to 95 dollars, reinforced in France in particular by a shortage of petrol, which led to further price increases at the pump.
There is no longer a negative oil – dollar correlation
Let us not forget either that the effect of a more expensive black gold weighs even more heavily when it is accompanied by a weakening of the euro. This is an unprecedented situation. Historically, the correlation between the price of oil and the US dollar is negative. But, partly because the US itself has become a major oil producer, this link has broken down. Oil now often costs more in local currency than it did in 2008, when prices in dollars were at their highest – but with the greenback at a low level. This is true for all of Europe, Japan and many emerging countries.
The situation is deteriorating
What are the implications for GDP? The recovery in the US in the third quarter turned out to be somewhat stronger than expected. The 12-month growth rate was 2.6%. Fossil fuel exports were one of the positive surprises. On the same basis, growth in the eurozone reached 2.1%, while the quarterly increase was only 0.2%. Household consumption was one of the main drivers, and inventory building supported activity in France. For the last quarter of the year, a contraction in GDP is expected due to high inflation and ECB rate hikes. Well-stocked inventories and a milder-than-feared start to the cold season have kept disaster scenarios at bay.
But consumers are seeing the first signs of a deteriorating financial situation. Although the unemployment rate in the eurozone fell to 6.6% in September, wage increases due to labour shortages in some sectors are still much lower than in the US. The danger of a wage-price spiral is therefore less acute. The downside is that inflation, which is hardly driven by wages, is weighing on consumer sentiment. At least two quarters of negative growth seem inevitable.
PMI indices show declines in activity
The PMI indices were hardly buoyed by hopes of a more accommodating monetary policy. They did, however, underline the superior potential of the US compared to the Old Continent. The manufacturing PMI for October stood at 50.4 points (-1.6), just in the expansion zone, compared with 46.4 points (-2) for the euro zone. The index pointed to a contraction for the fourth consecutive month. On the services side, a score of 47.8 points (-1.5) was found in the US against 48.6 points in Europe. Both indicate a contraction for at least three months. Tourism explains the difference in favour of the euro area.
The delay of a finally higher than expected Chinese Q3 GDP may partly explain these negative values. The interpretation of this additional delay is indicative of the current bias towards the downside. Often, data pointing to a weakening economy is welcomed, as it gives hope for a somewhat looser monetary policy.
