Investment strategy
October 6, 2022

European economies will face a challenging winter

October 6, 2022
Guillaume Menuet
Head of EMEA Investment Strategy & Economics
Judiyah Amirthanathar
EMEA Investment Strategy
SUMMARY

Elevated energy prices, rising inflation and falling consumer confidence are just some of the challenges European economies face as winter approaches. Our latest monthly bulletin examines the road ahead.


Energy worries remain centre stage, all eyes on Germany: Despite the news of damages to Russian natural gas pipelines, natural gas storage levels are now sufficiently high to suggest that unless temperatures fall markedly below seasonal averages, Europe is unlikely to have to resort to meaningful gas restrictions in early 2023. EU criticism of Germany’s €200bn energy support package is growing.

Confidence in free-fall while inflation still climbs: The macroeconomic outlook is deteriorating. German business and consumer confidence are in freefall, with the Ifo expectations measure approaching its pandemic-era all-time low of 72. The euro area composite PMIs for September point to an imminent GDP contraction. With euro area inflation jumping to a new record high of 10% YY, ECB speakers are erring on the hawkish side.

Watching politics and sovereign risks: The Italian hard-right wins the legislative elections, but falls short of a 2/3 majority that would have allowed for the possibility of destabilising changes in the Italian constitution. Bond investors’ reaction was muted, with the 10-year Italian BTPs German bunds spread remaining contained at 240bp, for now.

Global Investment Committee implications: We remain underweight European equities. We also remain strongly underweight on European sovereign debt at a time when the economy is struggling and recession risks are mounting, even if current yield levels have already risen meaningfully. • UK: Polls show Labour building a strong lead over the Conservatives. New PM Liz Truss’ mini-budget has not managed to instil much needed confidence in the targeted reboot of the economy through tax cuts and supply-side reforms. Meanwhile, the Bank of England is juggling the need to hike rate while delaying the start of quantitative tightening.

Fixed Income Outlook: In September 10-year Bunds and UK gilts declined by 5.2% and 9.7%, respectively. Year-to-date the performance of the European fixed income market is negative across the board. Relative to the BoE’s Bank Rate on a 15-year basis, the short-end of the UK gilt market looks very cheap relative to the longer-end.

What if?: Because of the jump in gilt yields, we think that demand will be much higher and that foreign investors might be attracted by the additional potential return that could be offered by currency appreciation in coming years.

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