Following a very strong month for European equities in January 2023 the question at the start of February was, had investors gone too far in pricing in peak inflation and the knock-on effect this would have on the interest rate cycle? The commentary from the ECB meeting at the start of the period certainly shed some light on the likely thinking of policy makers but drew little in the way of a substantive conclusion. Increasing rates rose by 50bps as expected, and signalling another upward move of the same amount on the 16th of March, Christine Lagarde, when asked at the subsequent press conference when rates would likely peak, stated “we will not be there in March”.
While such a comment is hardly a surprise as inflation remains light years from the ECB’s 2% medium term target, it is notable that year on year comparisons will now likely start to fall as a result of price declines for important commodities such as oil and gas, leaving the hope that any subsequent rate cuts may be minor in terms of their magnitude and the duration of the cycle. This optimistic scenario was further supported by Federal Reserve Chair Jerome Powell who stated he expected to deliver only “a couple” more increases.
All well and good for equities, but the optimism soon soured as US jobs data came in well above the level expected by the market. While ostensibly good news, the 517,000 increase in non-farm payrolls (189,000 expected) was interpreted as a sign that the market had indeed got ahead of itself, and the reaction was poor both toward this data as well as the 53 year low in the US unemployment rate at 3.4%. Actual European inflation data reported over the course of the month didn’t deviate too far from its expected course but there were notable exceptions particularly in Spain where the rate of price increases advanced to 6.1% year on year up from 5.9% in January and above the 5.7% expected by the market.
This was despite a cut in taxes on key foodstuffs countrywide which highlighted the challenges still remaining for policy makers. Company reporting started in earnest during the period, and while the full year 2022 results were of interest, it was the 2023 guidance that was the real focal point. While too early to form any proper conclusions, the outlook has so far been far from pessimistic, but caution has been expressed with a nod to the obvious dangers and the much heralded potential for a recession.
The reality is that in most cases it is still too early to speak of the full year 2023 with any great degree of confidence and for many it would be foolhardy to do so. In such circumstances we welcome the caution and see no need for elevated expectations even where the trajectory appears clear. Of those reporting, European banks were notable in terms of positive surprises, buoyed by ever increasing net interest income and as yet robust loan books.