With Eurozone PMI’s firmly below 50 in September 2023 indicating an economic contraction period for the region it would have been fair to expect that central banks had achieved the conditions required to tame inflation and that the interest rate tightening cycle could come to an end.
Despite an increase of 25bps to the deposit rate over the course of the month, the ECB’s subsequent commentary made it clear that that was as far as they needed to go for the time being. But while this may have signalled the peak, it was clear a subsequent cut could be some way off. Not only did the bank increase their inflation expectations for the full year as well as 2024, but Christine Lagarde stated that “ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target”.
Clearly the already declining PMIs are required to deteriorate further for the impact to be felt but perhaps more importantly the plateau for rates will be a long one as suggested by the “sufficiently long duration” remark. It’s this “higher for longer” narrative that spooked bond markets over the course of the month as the US Federal Reserve too appeared to suggest a similar course, despite holding rates where they were.
With the oil price moving substantially higher, Brent breached $95 a barrel, the spectre of stagflation raised its ugly head and the impact on both equities and bonds was evident. Weighed down by continued poor demand from China, Germany appeared to be suffering more than most as evidenced by a 17% drop in factory orders for August. The ECB now forecasts a decline in German GDP for the full year at odds with most other European countries who should post modest growth. To suggest that Germany was once again the “sick man of Europe” was likely too harsh and something strenuously denied by Bundesbank President Joachim Nagel who pointed to the strength of the labour market compared to the 1990’s when this phrase was last applied.
Much will depend on developments in China where the signals remain mixed with the outcome depending much on government stimulus as well as actions to resolve the issues surrounding property companies such as China Evergrande. The fact that the EU chose this time to launch an investigation into Chinese state subsidies for their electric vehicle industry risking retaliation for what is one of the most critical industries for European economic development was questionable.
But perhaps such spats are to become more commonplace as China’s curb of the use of Apple products in government backed agencies and state companies also occurred during the same month.