The DXY trade-weighted (Advanced Economies partners) index hit its highest level since 2002, appreciating by 1.8% in the past week (+11% yoy). As a result, the euro has depreciated near parity to the US Dollar (1.0001 on Tuesday). Investors have scaled back their expectations regarding European Central Bank’s tightening path, due to increasing uncertainty regarding the euro area macro-economic environment. Two-year Government bond interest rate differentials have widened by 38 basis points in July to 272 basis points (US vs Germany).
Higher energy prices due to the threat of gas shortages are dampening growth and exacerbating inflationary pressures. Note that the Nord Stream 1 natural gas pipeline, the major route of gas from Russia to Europe with a capacity to transport 55 billion cubic meters per year (equivalent to 54% of Germany's annual gas consumption or 13% of EU’s annual gas consumption), was shut down on Monday July 11th for annual maintenance, a procedure scheduled to last until July 21st. However, concerns are mounting that Russia will suspend or slowdown flows significantly, beyond the scheduled period. European natural gas prices (Dutch TTF) increased in the past week by +19% wow to €175/MWh, the highest level since early-March 2022.
Volatility in energy prices though remains high. The Dutch TTF price declined by 6% on Monday to €165/MWh as the Canadian government issued, a “time-limited and revocable permit” to exclude from its Russian sanctions the return of the repaired turbines that Gazprom cited as the reason for the decrease of natural gas flows to the 40% of the pipeline’s total capacity in June.
According to European Commission (June), the fiscal stance in the European Union is estimated to have been expansionary at circa +1.75% of GDP for 2022, following +1% of GDP in 2021. A contractionary fiscal stance of around -0.5% of GDP is forecasted for 2023, driven by the roughly complete expected phasing out of measures to mitigate the impact of the high energy prices.
Nevertheless, amid rapidly increasing energy and electricity prices, reduction of taxes, excise duties and other-related relief measures could instead be extended in 2023. The Eurogroup, on Monday, reiterated that overall fiscal policy should be prudent in 2023, in line with European Commission’s communication under the 2022 European Semester. Support measures should increasingly adjust towards targeting the most vulnerable households.
However, policymakers should be ready to react to the developing economic landscape. On the sidelines of the meeting, just a few days before the Commission publishes its Summer Economic Forecast, VP Dombrovskis gave an update expecting an upward revision for inflation and slower real GDP growth for 2022. Note that Q1:2022 euro area real GDP rose by +2.5% qoq saar (albeit +0.4% qoq saar, on average, for DE, FR, IT, SP, see graph below). For Q2:2022, consensus expectations have drifted lower towards growth of +0.8% qoq saar, from +2.8% in end-May.
UK Prime Minister Boris Johnson resigned from the leadership of the Conservative Party on Thursday. Johnson will remain as PM until his successor is elected. The winning candidate (and hence new Prime Minister) will be determined by a ballot among all the Conservative party members on September 5th.