Euro area: Conflicting signals
|After expanding by 0.2% q/q in the first quarter, the euro area economy started Q2 on a stronger footing than one could have feared, in light of renewed supply disruptions from the Ukraine war and Chinese lockdowns as well as weakening demand prospects from rising prices. While services activity continued to build momentum during April after the lifting of pandemic restrictions and increased spending on travel and recreation, growth in manufacturing output nearly stagnated as bottlenecks, rising prices and heightened uncertainty took their toll. German industry still presents the epicentre of the slowdown, with new orders contracting for the first time in two years. Another worrisome development is the indication that some firms are front-loading purchases in anticipation of further price rises, suggesting that inflation expectations are still adjusting upward. At the same time consumer confidence fell sharply during April, in a sign that spending might face increasing headwinds in the coming months.
Despite energy price inflation slowing down after commodity prices have stabilized, headline inflation reached another new record high of 7.5% in April, with core inflation surprising significantly on the upside at 3.5%. The continued building of underlying inflation pressures leaves little room for complacency from ECB and further upside risks loom from food prices in the coming months and tentative signs of wage growth picking up. With the possibility of further disruptions to Russian gas and oil supply looming as the EU readies another sanctions package, the risks to euro inflation remain firmly on the upside in our view.
With the economy holding up and inflation reaching ever new record highs, a growing number of ECB hawks are advocating a faster policy normalisation pace, especially amid signs of de-anchoring inflation expectations, with market- and survey-based measures now standing above the 2% goal. ECB President Lagarde struck a fairly dovish tone at the April meeting, reiterating the game plan to end QE in Q2 and stressing flexibility and data-dependency. However, a range of Governing Council members have since sent a message of urgency to the market, mentioning the possibility of a hike already in July this year, which is now also our base case. Markets have now priced in a total of 200bp of rate increases until end-2023, but with growth challenges mounting in 2023, we remain sceptical about ECB’s ability to deliver on these hawkish expectations.
Emmanuel Macron won the presidential election run-off against Marine Le Pen, making him the first incumbent to win re-election in France since Jacques Chirac 20 years ago. However, during his second term Macron is facing increasing headwinds, both from the economy and political fragmentation. With only 59% of voters endorsing him for a second term (compared to 66% in 2017), he has to govern a divided country and the weaker mandate could make it challenging for Macron to push ahead with his ambitious reforms of the pension, health and education system. To what degree he can implement his plans will depend on parliamentary elections held on 12 and 19 June.
Information on these pages contains forward-looking statements that involve risks and uncertainties. Markets and instruments profiled on this page are for informational purposes only and should not in any way come across as a recommendation to buy or sell in these assets. You should do your own thorough research before making any investment decisions. FXStreet does not in any way guarantee that this information is free from mistakes, errors, or material misstatements. It also does not guarantee that this information is of a timely nature. Investing in Open Markets involves a great deal of risk, including the loss of all or a portion of your investment, as well as emotional distress. All risks, losses and costs associated with investing, including total loss of principal, are your responsibility. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of FXStreet nor its advertisers.