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SPI Management Newsletter 27.10.23

ECB Maintains Interest Rate at 4% Amid Eurozone Economic Concerns

The European Central Bank (ECB) has opted to retain its interest rates, culminating a series of 10 consistent hikes. This move aligns with growing anxieties over the growth trajectory of the eurozone. While analysts had predicted this decision due to declining eurozone inflation rates and weakening economic indicators, the primary interest rate remains pegged at 4%, significantly higher than its historic low.

This rate pause precedes imminent rate decisions by other major banks, such as the US Federal Reserve and the Bank of England. Both are projected to maintain their rates amidst subsiding inflation.

ECB President, Christine Lagarde, while not dismissing potential rate hikes in the future, described talks of an imminent rate cut as “premature.” She emphasized the dampening effect of previous rate augmentations on economic activity. Moreover, she projected continued economic sluggishness for the rest of the year, attributed partly to the repercussions of heightened interest rates.

Addressing concerns about potential inflation surges due to the Israel-Hamas conflict and resultant oil price spikes, Lagarde underscored the evolved state of the eurozone economy. Unlike previous scenarios, present-day energy price hikes have a reduced likelihood of broadening into widespread price pressures.

In the eurozone, the economic frailty is becoming as pressing a concern as inflation, with anticipations of GDP contractions in the forthcoming quarterly reports. After touching 10.6% last year, inflation rates have descended to 4.3% this September, with further drops expected soon.

Reaffirming their commitment to inflation targeting, the ECB asserted the need to sustain the current rate levels for the foreseeable future. This is believed to be instrumental in achieving their inflation benchmarks. Meanwhile, the financial markets showcased modest fluctuations post the announcement.

Unraveling the Strength Behind the US Economy's Tenacity

In the face of the Federal Reserve's consistent elevation of interest rates over an 18-month span, the American consumer base stood robust. The latest data from the federal repository highlighted an unexpected twist: the US economy experienced an explosive 4.9% growth rate on an annualized scale during the third quarter. Such an assertive expansion, especially in the backdrop of one of the most stringent monetary tightening campaigns by the Fed, took many observers by surprise.

The linchpin holding this resilient economic performance together has been the surge in consumer spending. It wasn't just a minor contributor but stood as the towering force behind the Q3 economic boom, accounting for over half of the annualized increase. This spending enthusiasm, in many respects, can be traced back to significant job growth. This boom in employment gave Americans the confidence to delve into their wallets and keep the economic wheels turning. A closer look reveals more factors. Many felt their financial equilibrium was stronger than ever before, a sentiment reinforced by several indicators: solid personal balance sheets, stock market successes, the soaring value of the housing market, and the substantial savings accumulated during the pandemic's height.

However, among these optimistic indicators, cautionary notes emerge. A significant chunk of the pandemic savings has been used up, with a lion's share of the remaining portion residing with the wealthier demographic. Moreover, businesses, the engines of the economy, are beginning to tread with heightened caution. They're feeling the pinch of past interest rate hikes, with borrowing costs inching upward and casting a shadow on future economic activity.

Forecasts are suggesting a potential moderation in the pace. A few prognostications point towards the US GDP growth slowing down to just 0.8% in the next quarter. Some even anticipate it nearing stagnation by early 2024. However, this does not signal a unanimous consensus of an impending economic downturn. Key figures in economic governance remain hopeful. They believe that even if the pace slackens, a drastic downturn like a recession might not be on the horizon. However, the common thread across economic experts is an admission: predicting the exact trajectory of the complex US economy remains a challenging endeavor.

Adapted from WSJ, FT, NYT, Reuters, CNBC, The Economist

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