The sell off in global markets extended to a third week as concerns over how far central banks will raise interest rates to tame inflation weighed on investor sentiment. The blue-chip S&P 500 and technology focussed Nasdaq indices fell 2.6% and 3.2% respectively during the week.
The recovery across markets in July and early August was driven in part by expectations that the deteriorating economic outlook would encourage central banks to slow the pace of interest rate hikes but there has been a paradigm shift as policymakers have made it clear they will not stop until inflation is under control.
Investors are concerned that the more assertive tightening of monetary policy will push economies into a deeper, and longer, recession.
The European Central Bank is expected to reinforce the narrative on Thursday when it will announce its next interest rate decision. The question is not if, but by how much. Futures markets are leaning towards a 0.75% hike which would match the bank’s largest ever single increase.
Annual CPI inflation in the Eurozone climbed to 9.1% in August, a new record high in the 23-year history of the euro, and the ECB is a long way behind the curve having only just ended an 8-year period of negative interest rates.
Members of the ECB’s governing council have been more explicit in recent weeks, expressing a determination to raise interest rates more assertively whilst acknowledging it will increase the risk of recession and unemployment will rise. Some short-term pain is unavoidable.
The ECB has a more difficult path to navigate than its peers with divergent borrowing costs across the Eurozone. Germany can pay just 1.6% to borrow for 10 years but Italy and Greece must pay 4% or more. Higher interest rates will have a greater burden on the most indebted members of the shared currency union.
Many European governments are acting to reduce the impact of soaring inflation on households and businesses. Germany will impose a windfall tax on electricity producers to fund a €65 billion relief package, including an electricity price brake and one-time payments to pensioners and students.
The Bank of England is also feeling the heat and members of the government, including the new prime minister and chancellor have been critical of its failure to get to grips with inflation. The bank itself forecasts the 80% rise in the energy price cap to £3,549 per year in October will push inflation above 13% but others such Goldman Sachs predict it could hit 22% in January.
The expectation that the BoE will be forced to raise interest rates more quickly to 4% by Easter led analysts at HSBC to warn of a housing market downturn next year as affordability is constrained. At one point on Friday, nearly £1 billion was wiped off the stock market value of the UK’s biggest housebuilders.
Energy markets remained volatile and Brent crude fell 9% to $95 a barrel last week on concerns slowing economies, and more covid restrictions, will impact demand. A strict lockdown in Chengdu, a city of around 21 million people, was imposed after 157 new infections were recorded on Thursday.
To counter the fall in prices, Opec+ agreed on Monday cut supply by 100,000 barrels a day of supply from October. Although the amount is relatively insignificant, it sends a message that the cartel is ready to act against any interventions in the market such as price caps on Russian oil or allowing Iranian oil to be sold if a nuclear deal is reached.
There was even more volatility in European gas prices after Gazprom extended its shut down of the Nord Stream 1 pipeline, used to deliver gas from Russia to Europe via the Baltic Sea, indefinitely due to a “technical fault” at the Portovaya compressor station. The benchmark European gas price surged to €272 per megawatt hour, almost 400% higher than a year ago.
(Cover Image Source: Yiorgos Ntrahas)