Europe suffers following ECB rate hike

Our head of investment considers how European stock markets are suffering in response to a hawkish shift from the ECB, the newly unveiled energy support package in the UK, and fast-fashion brand ASOS.

EUROPEAN CENTRAL BANK

The European Central Bank decided to raise three interest rates by 75 basis points in an unprecedented move that represents the largest hike in its history. The interest rate on the main refinancing operations, marginal lending facility and deposit facility will be increased to 1.25%, 1.5% and 0.75% respectively with effect from 14 September. In terms of its growth outlook, the ECB cut it 2023 GDP forecast to 0.9% and its 2024 forecast to 1.9%. However, these figures are still in positive territory, indicating that the central bank believes the euro area will fend off a recession. However, it raised its inflation forecast for this year to 8.1% and next year to 5.5%.

The ECB has been dealing with criticism that it is behind the curve, acting too slowly on inflation. A decade on from Mario Draghi’s famous ‘whatever it takes’ speech, the ECB’s 75 basis point move sends a similar signal to the market that the central bank is indeed willing to go the extra mile to play catch up and bring inflation back down towards target.

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European stock markets are suffering in response to this hawkish shift from the ECB, with concerns about how the end of the era of cheap money will play out for business, which now will be forced to deal with higher borrowing costs and less flattering discounted cash flow analysis. Banks are the bright spot in today’s trade with this aggressive 75 basis point move potentially providing greater earnings potential on the back of higher net interest margins for the likes of Commerzbank and Deutsche Bank, which are both rallying by more than 3%. Ahead of the announcement, currency markets were largely pricing in today’s hawkish hike, which is why the euro was little changed after the announcement. The common currency is trading around parity against the greenback, with safe-haven demand and interest rate differentials providing major tailwinds for the US dollar in recent months.

TRUSS’S ENERGY PLAN

As her first major course of action in office, UK prime minister Liz Truss has capped consumer energy bills for two years at around £2,500, averting the anticipated 80% surge in October. She has also announced there will be a six-month support scheme for businesses. However, it is understood that this is still a work in progress with details yet to be released. It is expected that these measures could cost the government around £150 billion and will be funded by government borrowing.

Liz Truss insists her energy support package will have a positive impact on inflation, reducing price levels by ‘up to five percentage points’. However the hundreds of billions of pounds in borrowing and spending, particularly when combined with her plans to cut taxes, could in fact add to price pressures in the economy. There is also criticism that this very expensive plan that arguably could have been better targeted towards those most in need. Her package provides indiscriminate support for everyone in England, Scotland and Wales regardless of income, including those who are wealthy enough not to need any handouts.

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On a positive note, her plan is likely to support growth, potentially lessening the depths of the UK’s widely expected recession. However it comes at a cost of higher debt levels down the line. Today’s announcement has helped to moderately lift the pound off the lows after sterling slumped to the weakest level since 1985 this week yesterday.

ASOS

Shares in ASOS (LSE:ASC) have slumped by more than 4% after Jefferies cut the stock from a buy to a hold, slashing its price target from 2440p to 775p. The analyst team says ‘the slog continues’ for the online fashion brand and warns of ‘muted growth’ into next year.

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Just this morning, its fashion rival Primark’s parent company Associated British Foods (LSE:ABF) issued a profit warning citing rising costs and a strong dollar. The highly competitive, fast fashion, low price point segment of the retail space is suffering as the affordability crisis facing consumers, particularly at the lower end of the income spectrum who have far less disposable income left over at the end of the month if any at all. Shares such as Asos are likely to struggle from the macroeconomic pressures of rising inflation, supply chain bottlenecks, staff shortages and a looming recession. On top of that a depreciating pound and strengthening greenback is adding to its woes.