Entering 2023 there appeared to be a consensus expectation for European economic development to feature a peak in inflation followed by a recession in the first half of the year then a recovery sometime toward year end. Assuming the recession remained relatively mild in nature, this offered some hope for equity markets so far plagued by the fear of over-exuberant central bank tightening.
The strong rally seen in January 2023 for the equity market suggests this narrative is changing and that not only will any forthcoming recession be shallow but may even be avoided in many regions. Spurring this change in mindset was the fall in the rate of inflation for Europe’s main economies as December’s HICP numbers were published with Germany, Spain and France posting notable declines in the year-on-year change.
When digging into the detail many reasons could be found to suggest the moves might potentially be unsustainable, for example in Germany the government paid consumer’s December instalment for gas and district heating to ease the impact of previous gas price increases, but the fall was notable and a continued decline in the gas price combined with a milder than expected winter was highly encouraging. Whether central banks will be as enthused as the equity market remains to be seen as the first round of meetings will take place in early February.
Of course, we are discussing the rate of change in inflation, while meantime the absolute rate remains way above the ECB’s targeted level of 2%. Much work has been done to address this already with the ECB’s 4 rate hikes in 2022 totalling 250bps and the Fed’s 7 moves adding 425bps to US interest rates.
But for markets this appeared to matter little, with the focus purely on the graphs which suggested peak inflation had been reached. China also provided a note of optimism as the country appeared to be coping with the abandonment of the Covid zero policy from a public health perspective with the next stage a re-opening of this all important economy. The ease with which this happens and the subsequent impact on supply chains may well prove a decisive factor on the length and severity of the recession other economies may have to endure.