Markets Weekly podcast
What could Germany’s upcoming elections mean for Europe? In this week’s podcast, Philippe Gudin, Senior Economist at Barclays Investment Bank, discusses the possible outcomes and policy implications. And with inflation data improving in the US but hitting a nine-year high in the UK, Henk Potts, Market Strategist, explains the potential impact for investors.
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Henk Potts (HP): Hello. It’s Monday, 20th September and welcome to the Barclays Private Bank Markets Weekly podcast, the recording that will guide you through the turmoil of the global economy and financial markets.
My name is Henk Potts, Market Strategist for Barclays Private Bank, and each week I’ll be joined by guests to discuss both risks and opportunities for investors.
Firstly, I’ll analyse the events that moved the markets and grabbed the headlines over the course of the past week. We will then preview the German election. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.
It was a volatile week for financial markets last week, the rapidly decelerating activity and further regulatory crackdown. Last week it was casinos, and the fallout from the Evergrande situation has heightened concerns over China’s immediate growth prospects. We’ve seen a sell-off in Asian equities overnight.
Alongside that there was mixed messages from the latest inflation report and markets I think are increasingly coming to the realisation that variants, immunity length and distribution challenges means the global economy will be dealing with the virus for many years to come. All of which is weighing on risk sentiment as investors struggle to identify the next catalyst that will push equity markets higher.
The S&P 500 was in negative territory last week. It was only down six-tenths of 1% over the course of the trading week and is 2.5% below its 52-week high which it achieved on 2nd September.
In Europe equities fell for a third straight week, the STOXX 600 registering its longest such losing streak since October last year. The benchmark index is now at its lowest level in seven weeks.
The real action was actually in energy markets last week as European gas prices continued to surge and have now tripled during the course of this year as demand rebounds as economies reopen, but it’s really on the supply side that’s been driving prices higher.
There’s been reduced supply coming through from Russia. That’s due to technical and political reasons. Weather events have disrupted US gas exports. Renewables have been generating a disappointing yield during the course of this year and remember this is at a time when climate change policies had begun to phase out some of that traditional supply.
In terms of the impact, well, it does take some time to filter through to companies and consumers. Large companies tend to hedge their energy prices. Consumers are on fixed tariffs, certainly in the UK, perhaps less so elsewhere in Europe but pressure on small utilities companies may well force the government to intervene and of course higher energy prices could further stoke inflation.
Speaking of which, for months Fed officials have been claiming the decade high inflation prints were due to transitory pressures the August inflation report added some evidence to that theory. The consumer price index rose three-tenths of 1% from July. That was the smallest rise in seven months, significantly lower than the 0.9% surge registered between May and June.
On an annual basis, prices rose 5.3% but that was down from the 5.4% recorded in June and July which of course was the highest since 2008. If you look at core inflation which strips out the volatile food and energy components, prices rose just one-tenth of 1% from the prior month, the smallest increase since February and reflected the declines in components but have risen sharply as the economy reopened such as used cars, airfares and also insurance.
But the truth is it’s still too early for the Fed to claim victory in that transitory debate. The gauge was influenced I think by a range of factors, softening demand in the travel industry due to the Delta variant, the ending of school holidays and there are also signs of rising pressures in the housing market.
Turning to the outlook for US inflation over the next few months, we expect pricing in the service sector should continue to improve as demand recovers, but the easing of supply bottlenecks in the goods sector should lead to lower inflation.
For our US CPI profile for 2021, we’ve revised it lower. We now expect headline CPI to be at 5.2% in December and down to 2% year on year by the end of 2022.
In the UK data showed inflationary pressures are picking up. UK consumer prices jumped to their highest level in nine years in August, surging to an annual rate of 3.2%. Consensus was somewhere round about 2.9%, so significantly ahead of expectations, and in fact the 1.2 percentage point increase over the month was the largest increase on ONS records going back to 1997, although half the gain was in restaurant prices and compared to the August 2020 figure when the government launched its Eat Out to Help Out scheme.
The print certainly puts additional pressure on the MPC, which we know have become more hawkish in recent weeks and we’ll come on to that as we look ahead to this week with the Bank of England meeting scheduled for Thursday.
So that was the global economy and financial markets last week. On Sunday, 26th September, Germany will vote for the 20th parliament of the post war era, after which Angela Merkel will step down as Chancellor after 16 years.
To preview what we might expect, I’m delighted to be joined by Philippe Gudin, Senior Economist for Barclays Investment Bank.
Philippe, great to have you with us today. We’re one week ahead of the vote. What are the opinion polls telling us regarding the possible outcome of this election?
Philippe Gudin (PG): Yes, good morning, Henk. Well, opinion polls currently show a very fragmented political landscape and like in the past, no party seems to be in a position to gather significantly more than one-fourth of the vote, which is a trend common to most European countries actually.
It seems that for the first time, no two party coalition will be possible. In particular, the scenario which seemed most likely until before the summer, which was a coalition between the centre right CDU/CSU and the Greens, should be short of a majority in the Bundestag.
What we have seen during the summer is a strong weakening of the centre right CDU/ CSU and a spectacular comeback from the Social Democrats, which have been in third position for most of the last two years and are now leading in the polls.
Since the campaign really started, the popularity of Angela Merkel, who is not running for re-election, note that this is a premiere in the history of the German Federal Republic, so this popularity is not any more the determinant factor and the personalities of the three chancellor candidates from the main three parties probably play a more important role.
From that respect Olaf Scholz, the SPD candidate who is also outgoing vice chancellor in the grand coalition and finance minister, appears more experienced and he is trying actually to appear as Mrs Merkel’s natural successor.
So as it stands, there are five arithmetically and politically possible coalitions. Four of them would involve three of the mainstream parties of the different combinations between the three parties, the Social Democrats, the Greens on the centre left, the Christian Democrats, the Liberals on the centre right. And a fifth coalition would possibly take place which is a coalition between the Social Democrats, the Greens and the far left party Die Linke, which would be a very different story actually.
HP: So taking that into consideration, what are likely to be the main policy implications of the different possible coalitions for Germany?
PG: In the four first options I mentioned, a compromise would have to be found between the different programmes of the different parties, in particular on economic policies such as taxes, the limits on fiscal deficit, economic regulation to speed up the green transition or wage policy. Should the coalition lean towards the centre left, including both the Greens and the SPD and most probably with the Liberals or less likely with CSU, it would result in a slightly more expansionary fiscal policy with more expenditures in particular for reinvestments and more or less unchanged taxes.
It will mean that public deficits could be a bit higher than what we’ve seen over the last 16 years, that a return to the strict enforcement of the German constitutional dead brake could be postponed, but that would be only an inflection from past policies rather than a real breakthrough.
If by contrast the coalition leans a little bit more to the centre right, involving both the FDP and the CDU plus most probably the Greens or less likely the SPD, it would then mean that Germany would retain its very conservative approach to fiscal policy. A return to the enforcement of the dead brake rule would happen faster. Taxes would probably be cut and increasing public deficits in particular expenditure so it would be constrained.
It would imply a lower budget deficit and a more market-based instrument for, to speed up the green transition. There again that would imply only a few changes from past policies.
One scenario that would be a major breakthrough, which we qualify as a potential paradigm shift in German policies, it would be a coalition between the two left leaning parties, SPD and the Greens and the far left party Die Linke. Chancellor candidate Olaf Scholz did not rule out such an option, although I think it would probably not be his preferred option, and he stressed though that any coalition would have to be committed to NATO and to international naturalism which could be a red line for Die Linke which is rejecting the role of NATO.
In such a scenario, economic policies would clearly shift to the left, more public expenditures which would be financed equally by tax increases for the wealthiest and some companies and a higher public deficit than in the past.
Although it is unlikely that the dead brake rule would be removed because it would require a two-third majority in both chambers of the parliament, it is likely that its suspension would be extended and that some window dressing would be put in place to exclude green investments from its calculation for instance.
It would also mean more regulation, higher wages which could eventually undermine the competitiveness of the German economy.
HP: OK. Why don’t we broaden it out a little bit. What do you think will be the wider consequences for the European Union?
PG: That’s obviously a very important point. Germany under Mrs Merkel has been more or less running Europe for the past 16 years. In particular, the Franco-German couple has played a prominent role during this crisis with the decision to launch NGEU, the European recovery plan, with €800 billion financed by joint debt.
But that’s only one topic among many others including the banking union, the capital market union, the focus on the green and digital transitions and even more. In the four mainstream options that I described earlier we should not expect major changes to the German approach to EU policies.
Germany would remain fiscally conservative compared with countries like France or Italy but with some gradual and slow progress which could be possible in particular on banking union or on possible reforms of EU fiscal rules, especially if the coalition is leaning a little bit to the left.
But again that would not be a major breakthrough and Germany would just continue to play its role as a sort of intermediary between frugal northern countries and the big spenders of the south.
Under a left wing coalition involving the far left Die Linke, Germany would clearly join the Franco-Italian position on many issues in particular fiscal policies like revamping on the fiscal rules or turning NGEU, the recovery plan, into a more permanent mechanism to finance large investments.
Fiscal policies would be definitely more expansionary both in Germany but also in other countries. And the fact that there would be some wage increases in Germany would probably also lead to higher inflation in Germany compared with the rest of Europe, which would actually trigger a sort of macroeconomic rebalancing within the EU area which from that respect could be a positive thing.
In that case the what we could call maybe the magic triangle between Scholz, Macron and Draghi would be a major fact and I think there would be a major window of opportunity for Europe in the next six months to change quite more than in the past.
HP: OK. My final question for you is around timelines. When will we know who will be chancellor and what coalition will run Germany for the next four years?
PG: Well, good question actually. We won’t know that on Sunday night. We will know only on Sunday night what are the reactions of the main political parties to the results. We’ll just get some insight on how the different parties could play the game and because it will be a three-way coalition, we’ll have to wait for weeks or maybe months to know exactly what we get as a final agreement.
Even the chancellor will not be known for sure the night of the election. There is no automaticity for the largest party to nominate the head of the government even though it’s always been the case in the past because this would require the agreement of all coalition partners.
So that means that a new government may not be formed before the end of the year I would say, possibly even later given that the participation of three parties with quite different approaches and policies may require some persuasion on the three sides of it. So we’ll have to be patient actually.
HP: Well, thank you, Philippe, for your insight. It’s certainly set to be an interesting week in German politics and one that could set the scene for Europe for some time to come.
As we discussed the focus this week will be on the central bank meetings in the US and the UK. At the FOMC meeting policymakers will debate the taper timeline for its $120 billion asset purchase programme. We can only expect I think a conditional tapering signal at most at this week’s meeting. Given the reduced inflationary pressures and the disappointing jobs report, I think that gives the Fed greater room to manoeuvre.
We anticipate the Fed will delay its taper announcement till the November meeting, with a reduced rate of purchases to begin in December. So the risks are that the taper announcement may actually come later than that and markets will be looking for any hints around that.
The MPC meeting on Thursday will also be closely watched by investors. Perhaps they could argue there’s more of a chance of a surprise.
In terms of the policy outlook for the UK, we do not anticipate that the bank rate will rise before the end of next year although there are significant upside risks to this forecast, particularly if growth and labour markets continue to recover but inflation appears to be more ingrained than anticipated.
Markets are now pricing in two hikes totalling 40 basis points in 2022. And the MPC may believe that an early rate hike would help it deliver on its mandate, anchor expectations and mitigate risks of a more persistent inflation overshoot.
However, there is a huge amount of uncertainty from the pandemic. Recently we had some disappointing GDP numbers, some disappointing retail sales figures, so no doubt the Committee will be taking that into account.
We should also appreciate there’s no urgency to hike rates next year, which would be ahead of both their US and European counterparts. We should remember the Bank of England has a history of promising, then under delivering on rate changes so on the balance of probability, we expect the status quo to remain through the course of next year.
And with that I’d like to thank you once again for joining us. We will of course be back next week with our latest instalment, but for now may I wish you every success in the trading week ahead.
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