Macroeconomic update by François DUHEN, Chief Economist and Strategist CIC Market Solutions - First-half 2022

The first half of the year was marked by the Russian invasion of Ukraine and the ensuing high international tensions. The significant increase in risk aversion on financial markets and the surge in commodity prices, especially energy and food, reflected the uncertainty caused by the conflict and the severity of the sanctions imposed on Russia by European countries and the US in particular. On the health front, Europe and the US managed to keep the Covid-19 epidemic at bay thanks to the effectiveness of their vaccination coverage, after a complicated start to the year due to Omicron, but the situation was more difficult for China. The latter had to reintroduce restrictive measures, amplifying tensions on the global production chains and supply problems for companies. The combination of the 2021 inflationary shock, geopolitical tensions and supply difficulties resulted in a significant acceleration of price increases throughout the half year. In order to cushion the shocks to household and business confidence, governments implemented support measures via their fiscal policy, but this could not prevent the slowdown in some economic indicators in Europe and the US (fuelling fears of recession at the very end of the half-year). Central banks gradually chose to favour tackling inflation as part of their mandate, as they are faced with the risks of inflation expectations becoming unanchored and wages accelerating. This led to a particularly sharp rise in sovereign yields and impacted equity indices.

In the euro zone, the favourable economic outlook linked to the reopening and easing of health constraints (with GDP in the first quarter expanding 0.6% on a sequential basis) was quickly dampened by the outbreak of war in Ukraine on 24 February. The European Union (EU) has adopted several sets of sanctions against Russia, including an embargo on coal and oil imports by sea. Along with Moscow's decision to cut gas supplies to many countries, this has led to a sharp rise in energy prices. PMI activity indicators remained in expansionary territory thanks to an ongoing catch-up effect and substantial fiscal support (ca. 1.5% of GDP for euro-zone member states) deployed to mitigate rising inflation. On the other hand, the situation for companies was weakened by margins being squeezed between the rise in producer prices and wages and a slowdown in orders. Against this backdrop, the European Central Bank (ECB) started its monetary tightening in order to brake demand, needed to slow inflation, which has continued to move away from its 2% target (+8.6% year-on-year in June). This ECB thus decided: 1) to halt the pandemic emergency purchase programme (PEPP) in March and the historical asset purchase programme (APP) in July; and 2) to raise key interest rates at the next meetings starting in the summer. However, the risk of financial fragmentation quickly resurfaced again due to fears of a marked slowdown and the rapid rise in sovereign yields. The institution had to react in order to calm down the strong spread in sovereign yields between Germany and the most fragile countries, especially Italy. To do so, it latterly convinced observers of its determination after announcing that it was speeding up work to define a mechanism to combat this risk. In this tense economic context, the euro depreciated sharply, especially as the deterioration of the external accounts, likely to impact the currency, accelerated and fears were heightened by energy availability problems. Factoring in of the ECB's desire to tighten financial conditions alone made it possible to modestly contain the fall in the single currency

In France, activity was further affected by the epidemic rebound at the very beginning of the year (GDP contracted in Q1-2022: -0.2% sequentially) and, although the French economy is less dependent on Russian hydrocarbons than its European neighbours, inflation also accelerated significantly (albeit to a lesser extent than in the rest of the euro zone thanks to the tariff shield on energy prices). The half-year was also marked by political issues: Emmanuel Macron was re-elected President of the Republic, but his parliamentary alliance did not obtain an absolute majority in the legislative elections, which limits visibility on the policy that will be implemented during his second five-year term. Lastly, fears of energy rationing have gradually increased as nuclear production has fallen significantly due to the fact that many reactors are undergoing maintenance.

In the UK, although growth remained robust in Q1-2022 (+0.8% sequentially), economic indicators deteriorated rapidly as inflation gained traction due in particular to the increase in the price cap on energy prices, and accentuated by the effects of Brexit. To respond to this slowdown, the UK government stepped up fiscal support measures for households, but this remained limited, while the desire to rapidly rebalance the public accounts was maintained. The Bank of England continued its monetary tightening by raising key rates to 1.25% (+115bp since December 2021), but it is concerned about the risks to the economy, which fuelled sterling's depreciation against the euro and the dollar this half-year.

In the US, while the effects of the war in Ukraine are more moderate, the impact on oil and gas prices has increased gradually and added to inflationary pressures. This is particularly due to the embargo on Russian oil and gas, which has increased European demand for oil from the US. The impact on pump prices is also amplified by the lack of refining capacity. In addition, inflation has become more widespread (+8.5% annualised in June) and the risk of expectations becoming unanchored increased. The vigour of the labour market pushed wages up during the half-year. Faced with this inflation surge, the Fed accelerated the tightening of its monetary policy in June by announcing a 75bp increase in its key rates, after an initial 25bp lift in March and a second 50bp hike in May, bringing policy rates to 1.5%-1.75%. The aim now is to tighten financial conditions to curb demand, which has impacted financial markets heavily. However, while the economic slowdown is materialising, the consumption of services remains sustained due to the reopening effect linked to the lifting of health constraints and still significant accumulated savings of US households.

In China, implementation of the zero-Covid strategy gradually backfired, as it proved to be much less suitable for a more transmissible variant like Omicron. This weighed heavily on economic activity due to the strict lockdowns in several regions as of the first quarter. However, the improvement on the health front from the end of May onwards was a positive factor for the growth outlook, especially as monetary and fiscal support has been ramped up in recent months to support activity ahead of the Chinese Communist Party Congress in the autumn. In other emerging countries, inflationary pressures have remained sustained as the risks of shortages have intensified (energy and food). In this context, central banks have remained proactive in their fight against inflation with a general rise in interest rates which will likely intensify the economic slowdown.

Lastly, regarding commodities, the war in Ukraine has heightened the rise in prices, particularly for energy and food, insofar as demand is increasing without sufficient supply to meet it (OPEC countries’ production constraints, blocked food production in Ukraine). The forthcoming supply adjustment decided upon by OPEC has not proved sufficient to reverse the upward trend in oil prices in the long term. The oil price surge was also reflected in gas and food prices. Industrial metals were temporarily penalised by the Chinese slowdown.