Comprehensive Macro Report: The European Union (EU)
Growth, Inflation, Liquidity, Policy and Pathway For The FX Market
Background from Monetary Policy Statement
Globally, Q1’2024 has been a theme of Inflation re-acceleration, growth decline/recessionary expectations and rate cuts expectation by the Central Banks, and the EU is not an exception.
At the last MPC meeting held by the ECB on 7th March, the rate decision was to keep rates unchanged across the 3 financial indicators tools. The key commentary by the ECB governor, being:
Inflation has declined further
Domestic pressures on price remain high due to strong growth in wages
Interest rates are at levels sufficient enough for restrictive policy
Revised growth expectations in the near term
Revised lower expectations of inflation with an assumption of lower contribution by energy prices
The key variables to watch are established from the monetary policy statement.
Growth
Growth has remained marginally flat on a QoQ basis, declining from 0.1% in Q2/Q1’23 to 0.0% in Q3/Q4’23. However, on a YoY basis, growth expanded from 0.1% in Q3’23 to Q4’23
Assessing contributions to Real GDP, consumption expenditure contribution remain volatile declining to 0.15% in Q4’23 compared to 0.30% in Q3’23 and 0.17% in Q2’23.
Additionally, exports of goods contributed to Real GDP growth significantly, recovering from a persistent decline since Q4’22 to a net positive contributor to GDP in Q4’23
By Industry, the Public Sector, Construction, ICT, Real Estate and Agriculture, Forestry & Fishing sectors contributed positively to GDP growth in Q4’2023 on a QoQ and YoY basis.
Overall, growth in the EU remain tepid attributed to restrictive monetary policy mounting pressure on consumer demand, and while the ECB would keep rates at elevated levels, growth wouldn’t be expected to improve significantly.
Unemployment and Wages
Unemployment rate in the EU has also declined significantly from 12% to 6.53%, from a nominal perspective, unemployment rate seems to be elevated, but from an historical comparison, unemployment rate is at its lowest since 1991-1994
Wages growth is a key focus for the ECB, and perhaps an attributable reason to why inflation still remains elevated relative to the 2% medium target. Wages continue to grow significantly, and as the ECB highlighted, domestic pressures on prices remain high due to strong growth in wages
Retail Sales
Retail sales serves as a proxy for consumption expenditure. MoM retail sales remain range-bound, at -0.5% at the last release, but somewhat stuck between +0.5% and a low extreme end of -1.9%
However, on a YoY basis, Retail Sales seems to be improving with the last print at -0.7% from a low point at -3.3%. While improving, Retail Sales YoY still remain below pre-pandemic level
Inflation
Inflation in EU has declined significantly from the peak level of 10.6% in Sep’22, driven by lower contribution in Housing, Water, Electricity, Gas & Other Fuels, Food & Non-Alcoholic Beverages and Transportation.
While the Energy component of inflation has declined significantly, the pace is picking back up from a low point of -8% to -2.3%, as rising oil prices becomes a key risk.
Producer Price Index has also declined significantly from 40% levels to -8.30% well below pandemic levels.
PPI has had a significant pass-through effect on inflation
Liquidity
The ECB from the monetary policy highlights had indicated the slow down in the Asset Purchase Program. The ECB balance sheet has declined significantly from levels seen in 2022, but still well above pandemic levels.
Aggregates of Money Supply have also declined significantly across M3, M1 and M2, expected with a consistent restrictive monetary policy stance
A quick overview on the bank balance sheet of the EU, extracting the Gold & Gold Receivables and overlaying it with Gold prices and the US Fed Gold stock, it becomes evident that the EU has been increasing its Gold asset base, and this also follows synonymously with the rally in gold prices, while the US Fed has been flat in its Gold stock.
Additionally, just to re-iterate on the ECB comment at the MPC meeting regarding the slow-down in its Asset-Backed Securities Purchase Programme and Eurosystem Pandemic Emergency Purchase Programme, the chart below confirms that
Interest rates has also been restrictive:
Overall, the ECB have remained firm on mopping up liquidity in the system to keep inflation rate at bay, but it has also noted that the pressure on inflation is from the domestic environment within the labor market, specifically due to wages growth.
The FX Market
Macro events transformed to price action:
I have transposed some of the key data points on a macro scale into the Euro Futures charts, there are intraday swings from the week on week data release, while that is important, they largely fit into the macro picture as a whole.
In 2022, we had the highest level of inflation in the EU at 10%, then subsequent to that, inflation peaked and started to decline as a result the Euro gained, rallying above the levels posted before the start of rate hikes in June’22 at 1.07525
The EU also posted an intermediate low in March 2023, coinciding with the increase in the Gold & Gold Receivables balance sheet line.
As such, we see a correlation between Euro, Gold/EUR cross and Gold/USD cross. However, in Aug’23 we see the Euro set a new high at 1.13085 when the ECB decided to hold interest rate unchanged despite inflation being above the medium target, which resulted in the decline to prior levels when it increased its Gold asset line in the balance sheet, although recovering ( attributable to intra-week economic data release), but also setting another high when the ECB decided to keep rates unchanged at 4.5% for the second time at 1.11745.
From the market reaction, the range on the Euro continues to narrow from 1.13085 x 1.05310 to 1.11745 x 1.05310. The pathway forward I suspect is for the Euro to remain rangebound, rallying above and below short-term highs within the dealing range until any pivotal data causes a shift in narrative.
I personally, anticipate that the Euro could rally to 1.09605 or 1.1000 in Q2’24, if we remain within this rangebound price action and unclear stance in macro data around inflation and growth.