Germany on brink of recession as economy shrinks; central banks could raise interest rates to 15-year highs this week –

Just in: Germany is on the brink of recession, after its economy contracted in the last quarter of 2022.

German GDP fell by 0.2% in the October-December quarter, statistics body Destatis has reported. That’s worse than expected – economists had forecast that GDP would be flat.

Germany’s economy was hit by soaring energy prices at the end of last year, driving up the cost of living. Inflation hit 11.6% in October, as Russia squeezed energy supplies to Europe.

Household spending fell during the quarter, pulling growth down, Destatis explains:

After the German economy held up well in the first three quarters despite difficult conditions, economic output decreased slightly in the fourth quarter of 2022.

In particular, the price-, seasonally and calendar-adjusted private consumer spending, which had supported the German economy in the course of the year to date, was lower than in the previous quarter.

A recession is commonly defined as two successive quarters of contraction, so Germany would be in recession if its GDP shrinks in the current quarter (January-March) as well.

Bond prices have rapidly rebounded since the start of the year from last year’s historic sell-off, as markets bet that interest rate rises will slow and, in the case of the US Federal Reserve, even go into reverse, the Financial Times points out.

But some investors have doubts, the FT says, so this week’s central bank decisions could cause jitteriness – as higher interest rates will slow growth.

“I think it’s just a matter of the market kind of waking up to what the macro environment really is, as opposed to what they hope it is,” said Monica Erickson, head of investment grade credit at DoubleLine Capital.

Erickson adds:

“[It] is going to be super difficult again for the Fed to . . . get inflation down to that magical 2 per cent number without putting us into a recession.”

Maureen O’Connor, global head of high-grade debt syndicate at Wells Fargo, said:

“The credit markets are effectively pricing in a no-recession outcome. But that’s not the consensus base case that most economists are forecasting.”

More here.

There could be splits at the major central banks this week over how high interest rates need to rise to tackle inflation.

Thomas Hempell, head of macro & market research at Generali Investments, predicts that the US Fed will slow its tightening pace with a 25 basis point hike on Wednesday, while the ECB and Bank of England will “will stay the course” by lifting their key rates by 50bp (half a percentage point).

Given still high inflation and the easing in financial conditions, Hempell expect a hawkish tilt for the outlook to prevail. But there could be “mounting rifts over the policy outlook”, he tells clients:

We expect the hawks to still prevail – for now. Most clearly so at the ECB. In a shaky December compromise, some hawks bended to slowing the rate hikes to 50bp in exchange for hawkish forward guidance and a binding commitment to quantitative tightening. Some doves have revoked this truce recently, pushing for smaller hikes after Feb. as headline inflation eased into single digits.

Yet more likely, the ECB will stay the course. Amid high core CPI (up 5.2% in Dec.), economic resilience (we no longer expect a winter recession), rising wages and hawkish pledges by President Lagarde we see the hawks still prevailing. Markets underestimate the terminal rate, which is at 3.5% in our books.

By contrast, as the Fed will (probably) hike by only 25bp, the focus will shift to the number of remaining like-sized hikes its policymakers expect, Hempell adds:

The Fed’s Dec. dots suggest further moves in both March and May. Markets, cheered by moderating inflation and weaker leading indicators, don’t buy this any longer. Dovish FOMC members are stressing more eagerly the Fed’s dual mandate (inflation and employment).

Ultimately, though, led by Chair Powell, the FOMC is still likely to lean towards a steady approach to inflation fighting as fin. conditions have recently eased. So expect the outlook language of “ongoing increases” (plural) to be maintained in the statement.

As predicted, European stock markets have dropped in early trading as investors brace for interest rates to be hiked to 15-year highs later this week.

The UK’s FTSE 100 index is down 46 points, or 0.6%, at 7719, away from the four-year highs set in mid-January.

Insurance group Legal & General are the top faller, down 2.3%, after announcing that long-serving chief executive Nigel Wilson to retire after more than a decade in the role.

Asia-Pacific-focused financial groups Prudential and Standard Chartered are both down around 2%, followed by retailer Frasers (-2%) and online grocery tech business Ocado (-1.7%).

Germany’s DAX and France’s CAC have both dropped around 0.5%.

Neil Wilson of Markets.com says all eyes are on the Federal Reserve, and what it says about the future path of monetary policy on Wednesday.

Two key things remain unknown – how high and for how long. I don’t think even the Fed knows the answers to these questions at the moment, but it will undoubtedly want to push back against the dovish read the markets have taken.

Stocks are “on the back foot this morning”, he explains, as attention shifts to this week’s Federal Reserve meeting, as well as the European Central Bank and Bank of England meetings on Thursday.

Wilson adds:

Despite the weakness this morning for risk assets, global stock indices are set to close to the month firmly higher. The FTSE 100 is up around 4% this month but lags peers after a much more resilient 2022 than most.

The Nasdaq is up around 11% and the DAX 8% higher in January as investors looked through signs of economic weakness and instead decided that peak inflation was behind.

Sweden’s economy ended 2022 on a weak note, with the economy shrinking in the last quarter as inflation and the war in Ukraine hit households and businesses.

Preliminary GDP figures from the Swedish Statistics Office this morning shows that gross domestic product (GDP) fell 0.6% in Q4, compared with the previous quarter.

Economists surveyed by Bloomberg had expected an expansion of 0.2%.

Neda Shahbazi, economist at Statistics Sweden, says:

“GDP decreased in December, indicating a weak ending of last year.

The development for 2022 as a whole was however slightly above the historical average seen during the last decades, but this is mainly explained by low economic activity during the first half of 2021 rather than a clear increase in GDP during 2022.