Further rising inflation rates are forcing the central banks to take ever more stringent monetary policy action. A recession seems inevitable, and the rising number of corporate profit warnings is already casting its shadow. In addition, the Ukraine war threatens to escalate with the annexation of eastern Ukrainian areas by Russia – the use of nuclear weapons can no longer be ruled out.
The series of bad news doesn’t end. Inflation rates continue to surprise on the upside, in Germany consumer prices have risen into the double-digit percentage range for the first time in more than 70 years. There are increasing indications that inflation expectations among the population are being unanchored. Inflation threatens to become a self-fulfilling prophecy. The central banks must take decisive action to counteract this.
No end to rate hike cycle in sight
Commerzbank is now assuming that the ECB will increase the deposit rate by the first quarter of next year, not just to 1.75 percent as previously expected, but to 3 percent straight away. On the one hand, the analysts justify this with the risk of inflation expectations being unanchored. On the other hand, they are assuming that inflation will prove more stubborn in the coming year than previously expected due to the energy crisis and are now expecting a price increase of 7.0 percent in 2023 instead of the previous 5.2 percent.
In the USA, too, there is no end in sight to the rate hike cycle. Despite the fact that interest rates have already risen sharply, the labor market report for next Friday should still be very solid. The US Federal Reserve has little choice but to keep raising interest rates to deal with rampant inflation. Because central bankers have little influence on the supply side, they take measures to dampen demand.
Bank of England shows the dilemma monetary policy on
In the meantime, it is a foregone conclusion that economies on both sides of the Atlantic will slide into recession. This is likely to be all the more severe the more the central banks raise interest rates. The central banks seem willing to put up with this in order to get inflation under control. At the same time, the increasing number of profit warnings shows that the gloomy economic environment has reached companies. The reporting season for the third quarter, which is about to begin, will be difficult.
Events on the British financial market have shown that the normalization of monetary policy will be anything but easy. Due to the increasing turmoil on the local bond market, the Bank of England felt compelled to intervene to stabilize the situation by means of “temporary” bond purchases. The planned quantitative tightening has been postponed for the time being. Other central banks could very quickly face a dilemma because of the mountains of debt that have accumulated since the financial crisis, because debt and higher interest rates do not mix well.
The market is only visually cheap
The Ukraine war has what it takes to trigger completely different volatilities on the markets than the central banks. With the annexation of eastern Ukrainian areas and their incorporation, the conflict threatens to get completely out of control. Because as soon as these regions become “Russian,” the Kremlin understands that hostilities there can be declared direct attacks on state territory. President Putin has repeatedly stated that in such a case he would not shy away from using nuclear weapons – experts take this threat very seriously.
Even without a nuclear war, the stock markets are likely to be far from bottoming out. With a price/earnings ratio of currently 10, the DAX is cheap, but given that corporate profits are likely to be revised soon, this is likely to be little more than an optical illusion. An evaluation indicator that has proven itself in times of crisis, the price/book ratio, is only just under 9,500 points in the DAX at 1. A test must be expected in these times of crisis, and it will go even lower in the event of a nuclear strike.
By Manuel Priego Thimmel
FRANKFURT (Dow Jones)
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