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Weekly Focus – Slowing Growth in the Euro Area

Markets have continued in risk on mode this week with rising equities and 10-year US treasuries back at May levels close to 1.70%. The demand for inflation protection remains strong and the US break-even inflation rate is now close to a historical high of 3%. Oil and gas prices have been broadly unchanged at elevated levels this week. The high energy prices affect metals as well and we are seeing refined metal prices at very high levels amid continuing production shortages and power outages. The demand boost from China’s pandemic-era stimulus is over, though, and this is particularly visible in iron ore prices. We have taken a closer look at metal prices in Research Global – Power crunch supports metal prices despite fading demand, 18 October.

Euro area PMI’s disappointed as the service sector slowed significantly which brought the composite PMI to a six month low of 54.3 in October from 56.2 in September. Manufacturing activity on the other hand remained solid, while output prices accelerated to the highest pace on record. In Japan, the service sector is now back in expansionary territory for the first time since the start of the pandemic due to the end of the state of emergency.

In China, a deal for Evergrande to sell a 51% stake of its property management collapsed and we think that Beijing is soon likely to take more concrete action to support the broader credit markets. New home price growth stalled in September for the first time since the start of the pandemic. While slowing credit growth is the key driver explaining slower house price growth, rising uncertainty towards property developers also weighs on home sales.

Next week, flash euro area GDP figures will likely reflect that the service sector was not completely up and running in Q2 and thus, Q3 growth will remain on the high side. The ECB also meets to discuss monetary policy but we expect they will attempt to make the meeting as uneventful as possible. The meeting is largely a prelude to the December meeting, where new staff projections will base the foundation for the exact calibration of its instruments. In a surprise move, the key Governing Council member, German Bundesbank President Jens Weidmann, resigned his post this week, which will likely leave room for a successor with more moderate monetary policy views.

US Q3 GDP release and PCE inflation numbers will likely draw high interest in the market. The rates market now expects about two hikes next year and for these expectations to hold, in particular, inflation will need to stay elevated above Fed’s average target of 2%.

The Bank of Japan (BoJ) also meets to discuss monetary policy next week. While the pandemic programme has increased loans, they have been unwinding government bonds for about a year now. The October reopening of the economy is convenient at a stage where exports are declining sharply amid lack of supplies. It will be interesting how the BoJ assesses the recent significant JPY weakening after the cabinet has been out warning for the need of a stable currency this week. We expect no changes to the bank’s QQE with yield curve control.

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Danske Bank
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