- European Central Bank interest rate at 4.5%.
- EU growth forecast revised down to 0.8% for 2023.
- Monetary policy expected to hold steady to soften impact on economic health.
The European Central Bank (ECB) raised its main refinancing interest rate to 4.5% in September, the highest it has ever been. Minutes from their meeting indicated a split position on rates, with concerns that less hawkish rhetoric could be inflationary. On the flip side, some ECB members were cautious of how higher rates have affected the health of the economy. After voting for the rise, the ECB indicated that rates may be at their peak, with a pause on the cards going forward.
European GDP growth came in at an annualised 0.5% at the end of June this year, with growth returning to a relatively modest level after the trough and peak of Covid. Forecasts for 2023 have been revised down to 0.8%, from the 1.0% expected earlier this year, and 2024 growth is billed to hit 1.4%, down from an initial 1.7%.
Long term bond yields have risen, pushing borrowing costs higher and trimming inflationary pressures. Given perceived strains on economic health in the region, the ECB believes they are able to bring inflation down to their 2% target without further hikes, providing current monetary policy levels are maintained long enough. This trajectory is intended to soften the landing, should we see a recession kick in.
How likely is a contraction?
Unlike in the UK, we have not yet seen unemployment start to rise in the Euro Area. Consumer spending has been back to pre-Covid levels for some time, and wage growth in the region remains strong. However, consumer confidence has fallen two months in a row and residential property prices continue to slide. Economic indicators are painting a mixed picture for policymakers and investors alike, supporting the need for a steady approach to policy. Should the economic picture deteriorate further, the ECB will be pleased it has taken a breath, though volatility in markets will remain should strong economic readings persist.
Portfolio exposure to European markets has been modest, when compared to other developed regions. Our allocation to European equities within core mandates held up very well last year amongst geopolitical tensions, higher commodity pricing and a rotation towards value investing. Fallout from March’s banking failures trimmed a positive start to this year. Within our ESG portfolios, a more growth-focussed equity allocation has added 7.6% in sterling terms year to date.
As we have written before, less aggressive monetary policy from the ECB or any other main central bank is going to be supportive for risk markets as the pressures felt from higher rates and tighter policy ease.