Become a Creator today!Start creating today - Share your story with the world!
Start for free
00:00:00
00:00:01
The Macro Brief – Europe’s inflation fight
25 Plays1 year ago
Simon Wells assesses the efforts of European and UK policymakers to bring inflation under control. Disclaimer: https://www.research.hsbc.com/R/61/kzdSDbW Stay connected and access free to view reports and videos from HSBC Global Research follow us on LinkedIn https://www.linkedin.com/feed/hashtag/hsbcresearch/ or click here: https://www.gbm.hsbc.com/insights/global-research.
Hosted on Acast. See acast.com/privacy for more information.
Recommended
Transcript
Introduction and Podcast Overview
00:00:00
Speaker
Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
00:00:11
Speaker
Make sure you're subscribed to stay up to date with new episodes.
00:00:14
Speaker
Thanks for listening.
00:00:15
Speaker
And now onto today's show.
00:00:17
Speaker
The following podcast was recorded on the 19th of October 2023 by HSBC Global Research.
00:00:23
Speaker
All the disclosures and disclaimers associated with it must be viewed on the link attached to your media player.
00:00:27
Speaker
Remember, you can follow this weekly podcast on Apple and Spotify, or wherever you get your podcasts, by searching for The Macro Brief.
00:00:38
Speaker
Hello, I'm Piers Butler and welcome to the Macrobrief.
Interest Rate Hikes in the European Economy
00:00:41
Speaker
This week we're focusing on the outlook for the European economy.
00:00:45
Speaker
Both the ECB and the Bank of England have raised interest rates sharply through the course of the year in an attempt to bring soaring inflation under control.
00:00:54
Speaker
Are the plans working or will more pain be needed?
00:00:58
Speaker
To discuss that and more, I'm joined by Simon Wells, Chief European Economist.
00:01:02
Speaker
Simon, welcome.
00:01:03
Speaker
Hi.
00:01:04
Speaker
So Simon, you recently presented at our Global Investment Seminar in London and I was in the audience and I have to say you were responsible for sending a cold shiver down my spine.
00:01:14
Speaker
Sorry about that.
00:01:15
Speaker
Well, the reason for that is that you took us back to 1989, which is etched in my memory because I was unfortunate to have a variable rate mortgage.
00:01:26
Speaker
And to your point, that was real pain compared to what we're experiencing now.
00:01:30
Speaker
That's right.
00:01:31
Speaker
In October of 1989, the then UK finance minister, John Major, famously said that inflation had to go and if policy wasn't hurting, it wasn't working.
00:01:41
Speaker
And at that point, UK policy rates had just hit 14.88%.
00:01:44
Speaker
So yes, I can imagine you were feeling the pain.
Inflation Trends and Forecasts
00:01:50
Speaker
The point being, though, that UK inflation didn't fall until the second quarter of 1992, and the economy didn't return to growth after a long recession until the third quarter of 1993.
00:02:03
Speaker
So the point is that at the point John Major had started talking about pain, there was over two and a half years more of pain before inflation finally came down.
00:02:12
Speaker
But today is different, and one wonders whether that level of pain is going to be necessary.
00:02:18
Speaker
After all, you've just published your latest Eurozone inflation briefing, and that highlights that inflation fell sharply in September, and you expect another big fall in October.
00:02:30
Speaker
That's right.
00:02:30
Speaker
But there's really two things going on in inflation.
00:02:33
Speaker
The first is the impact of last year's big energy price rises dropping out.
00:02:39
Speaker
So October really was the peak of energy prices last year.
00:02:44
Speaker
Now that's dropping out, we're seeing some very sharp falls in the annual rate of inflation, known as base effects.
00:02:50
Speaker
So yes, but I think September and October really will be the biggest falls.
00:02:55
Speaker
After that, we're looking more at service sector inflation.
00:02:58
Speaker
That's stickier, that's higher and not coming down.
00:03:02
Speaker
And of course, part of the reason it's not coming down is because wage growth is quite high.
00:03:07
Speaker
And if you're a service sector firm, well, I don't know, two thirds of your cost base is labour costs.
00:03:12
Speaker
You're going to have to pass some of that on.
00:03:14
Speaker
And so inflation in an underlying sense is taking longer to come back down.
ECB's Monetary Policy and Fiscal Effects
00:03:20
Speaker
Is that why long term yields are still grinding higher?
00:03:23
Speaker
I think it's related.
00:03:25
Speaker
Again, there's a few things going on.
00:03:26
Speaker
But the first is the central banks have been telling us for some time that once rates reach their peak, which we think they have, they're going to stay at those levels for a long period, precisely because of what I was just saying about that stickiness of inflation.
00:03:41
Speaker
I think a few months back, markets thought perhaps interest rate cuts both in Europe and the US were going to come quicker than the central banks were saying.
00:03:50
Speaker
And now they're pushing out those expectations for rate cuts.
00:03:54
Speaker
And that's pushing up longer term yields.
00:03:57
Speaker
Another factor, of course, which is fiscal policy, is that past episodes of bringing down inflation have often been accompanied by fiscal tightness.
00:04:05
Speaker
And that is not what we're seeing at the moment.
00:04:07
Speaker
If anything, in Europe, we're still seeing a relatively loose fiscal policy.
00:04:11
Speaker
So the debate really at the moment revolves around what are the central banks likely to do?
00:04:16
Speaker
Are they going to stay at the current high levels or is there a risk that they go higher?
00:04:21
Speaker
Well, we're sort of taking the central banks at their word.
00:04:24
Speaker
And against the backdrop of the economics, it does look like rates have to stay where they are for some time.
00:04:29
Speaker
So our central case is that the ECB doesn't cut until December of 2024.
00:04:35
Speaker
By that point, it should have some forecasts out to 2027 and inflation should have come down.
00:04:40
Speaker
So it should have the confidence to do so.
00:04:43
Speaker
But in the near term, there is, of course, a risk that they have to raise again, depending on the incoming data.
00:04:49
Speaker
And going back to that conversation of pain that we started with, policy rates in this cycle would peak a lot lower than they did in the late 80s and early 90s, despite, if anything, inflation being higher.
00:05:04
Speaker
So the ECB meets on the 26th of October.
00:05:07
Speaker
What are we expecting?
00:05:08
Speaker
And if we're not expecting a lot of action on rates, is there any other actions that are likely to take?
00:05:13
Speaker
Well, good question.
00:05:14
Speaker
I think rates, it would be a big surprise if they changed rates.
00:05:17
Speaker
I think most of the ECB's governing council now seem in a mindset to talk about
00:05:22
Speaker
the duration of where rates are rather than necessarily the peak.
00:05:27
Speaker
But you're right in that the conversation may start shifting to other areas of policy, notably balance sheet policy.
00:05:35
Speaker
So at the moment the ECB is still reinvesting the proceeds of maturing assets that it bought under its pandemic emergency facilities and it may decide it wants to stop that reinvestment early.
00:05:48
Speaker
or it may discuss more fundamental framework changes to the way it implements monetary policy.
00:05:55
Speaker
But whilst that discussion starts in October, the ECB is conducting a review and we probably won't see any major changes until that review reports back, which should be towards the end of Q1 next year.
00:06:08
Speaker
As they're doing that review, is Italy on their minds?
00:06:11
Speaker
Well, Italy will certainly be on their minds, of course, because the bond spread has widened out quite a lot.
00:06:17
Speaker
And in absolute terms, the level of borrowing costs for Italy has risen to pretty high levels, almost 5%.
00:06:25
Speaker
So, yes, they're always worried about fragmentation across areas of the eurozone.
00:06:30
Speaker
And going back to that reinvestment policy, the pandemic emergency purchase programme, the reinvestment from that can be skewed in a flexible way.
00:06:38
Speaker
It's their first line of defence against spread widening in a particular country.
00:06:43
Speaker
So yes, to do away with that earlier potentially removes their first line of defence and a key tool in maintaining the monetary transmission mechanism
UK Fiscal Policy and Economic Risks
00:06:54
Speaker
across Europe.
00:06:54
Speaker
So yes, they will be worried.
00:06:56
Speaker
Let's turn to the UK.
00:06:58
Speaker
What, if any, room does the UK government have to cut taxes ahead of an election?
00:07:03
Speaker
Well, not a lot because, of course, UK debt ramped up through the financial crisis.
00:07:08
Speaker
It then ramped up again through COVID.
00:07:12
Speaker
So we're looking at a debt ratio of almost 100% of GDP.
00:07:18
Speaker
That's fine when interest rates are zero and negative in real terms, but now they're not.
00:07:23
Speaker
And so the UK's debt servicing costs will increase.
00:07:27
Speaker
well exceed £100 billion this fiscal year, I expect, putting it to be like the third biggest line of public sector expenditure after the NHS and state pension.
00:07:39
Speaker
So there isn't much more room to borrow.
00:07:43
Speaker
So that means any tax cuts would have to be funded with expenditure cuts, which obviously is very difficult politically ahead of an election.
00:07:52
Speaker
So I think any changes in UK fiscal policy are likely, in all honesty, to be fairly modest.
00:07:59
Speaker
Now, I don't like finishing on a negative note, but do we have to accept, putting all of this together, that there is a risk of much more pain ahead or even delayed pain?
00:08:08
Speaker
I think there is a risk of both of those.
00:08:11
Speaker
As I said, it would be very unusual to get inflation back from double digits sustainably to target with what's still fairly historically low level of policy rates.
00:08:22
Speaker
But we have to look at the positives, which are the labour market has been remarkably strong.
00:08:27
Speaker
We are past the worst in terms of the inflationary squeeze on incomes.
00:08:32
Speaker
So wage growth is now outpacing the rate of inflation, comfortably so in the UK.
00:08:38
Speaker
So from a consumer's point of view, regarding their incomes, we might be past the worst.
00:08:43
Speaker
And once their incomes start to build in real terms, they have more spending power.
00:08:47
Speaker
So we might just get inflation back
00:08:50
Speaker
without recession or a large rise in unemployment.
Global Economic Updates and Closing Remarks
00:08:53
Speaker
Simon, thank you for ending on a positive note and thank you for joining us today.
00:08:57
Speaker
Thank you.
00:09:01
Speaker
Let's wrap up the podcast with a few highlights from the rest of the global research team.
00:09:05
Speaker
China has published its GDP data for the third quarter, and it exceeded expectations, accelerating to 1.3% quarter-on-quarter or 4.9% year-on-year.
00:09:17
Speaker
The consumption-led recovery continued to broaden out.
00:09:20
Speaker
Manufacturing activity picked up, but property investment showed a deeper contraction.
00:09:25
Speaker
Our China economics team expects the focus to turn towards longer-term structural growth as the recovery steadies.
00:09:32
Speaker
Our metals and mining team has just published our latest metals quarterly.
00:09:36
Speaker
And that weakness in China's property market remains a concern, along with global economic uncertainty.
00:09:42
Speaker
Despite this, most metals prices have corrected, and our team think any supply shock or demand recovery could pose upside risks to spot prices.
00:09:51
Speaker
And finally, our Industrials team have updated their proprietary HSBC Global CapEx monitor.
00:09:57
Speaker
2023 has been another strong year of global capital expenditure growth at just under 9%.
00:10:03
Speaker
But Sean McLaughlin and Jonathan Day see that slowing next year to below 2%.
00:10:08
Speaker
Pockets of strength include software, airlines and electricity, with building materials and construction the weakest.
00:10:15
Speaker
If you'd like to know more about that or any of the reports, please email askresearch at hsbc.com.
00:10:25
Speaker
So that's all from us.
00:10:26
Speaker
Don't forget to follow the podcast on Apple and Spotify or wherever you get your podcasts by searching for The Macro Brief.
00:10:33
Speaker
Thanks very much for listening.
00:10:35
Speaker
We'll be back next week.
00:10:37
Speaker
Thank you for joining us at HSBC Global Viewpoint.
00:10:40
Speaker
We hope you enjoyed the discussion.
00:10:43
Speaker
Make sure you're subscribed to stay up to date with new episodes.