The Cambridge Weekly – 25th July 2022

Economy weakens but central banks persevere

Global investors tend to be quite US-focused, as the world’s largest economy has an outsized impact on trends across the world. Last week though, attention was on the other side of the Atlantic. European economic data caught the eyes of traders – and, unfortunately, not for the right reasons. Both consumer and business sentiment surveys indicated unexpected weakness, heralding a downturn across the continent.

What do the bond markets tell us?

The impact of rising inflation has become a self-evident fact of life in 2022. An unexpected series of global cost shocks, coupled with tight labour markets across most of the developed world, has led to the kind of steep price rises not seen in a generation. For most, there is, unfortunately, more bad news to come. Faced by faster than expected price hikes and aggressive countermeasures taken by central banks, capital markets have adjusted their expectations for inflation and interest rates.

The ECB carrot is back

The European Central Bank (ECB) raised interest rates by 0.5% points last Thursday, defying market expectations for a 0.25%-point increase. The deposit rate is now at 0%. To put this into an historical context, for the first time in eight years, banks will not be penalised with negative rates for parking money with the ECB. Yet, it is important to remember, as we described in the previous article, investors are predominantly interested in what the ‘peak’ interest rate will be, once the tightening cycle is completed.