Economy in Brief: July 2022

CFOs in the U.K. responding to the Deloitte survey paint a dour picture of current circumstances and a picture of difficult circumstances for the coming 12 months. Among the ten elements in the current survey, the highest standing goes to the cost of credit being high, followed by a very high ranking for financial and economic uncertainty, a moderately high reading for demand for credit for the next year, and a moderately firm reading on corporate leverage. These responses show us that CFOs are wary about credit costs, needs for credit and about financial uncertainty.

The lowest rating among these current conditions is for the attractiveness of corporate debt. Clearly in this environment with high inflation and rising interest rates, corporate debt isn't attractive. This is the lowest rating in the survey on this timeline for this component. As an overall view, there's also an extremely weak reading for the financial prospects compared to three months ago. That assessment has been lower less than 5% of the time. And in a related low ranking, CFOs rate credit availability as quite poor and equity issuance as unattractive. Bank borrowing is also viewed as unattractive. There is a low, 31 percentile standing, in response to the question it's a good time to take risk. Only one third of the surveyed CFOs think that it's a good time to take risk.

Turning to some of the key metrics for 12 months ahead, the two lowest responses are for operating cash flow and for cash (or equivalent) levels. Operating margins also get very low assessment standing in the lower 5% of their historic queue of values. Dividends and share buybacks show a standing in the lower 10% of their historic queues. CFOs give their expected revenues a lower one-third standing for the next 12 months. Capital expenditures have a lower 25 percentile standing. Ranking very high, of course, are costs: operating costs have a 97.8 percentile standing as do financing costs.

Looking at the survey responses by quarter, much of this weakening has occurred within the last two quarters. Almost any category that you would consider a good response has deteriorated sharply over two quarters; all those considered bad responses have increased sharply. The outlook portion of the survey mostly began to deteriorate sharply as of Q1 2022. Deterioration has continued or worsened into Q2 2022.

Looking at changes since Q4 2019, which takes us back before the COVID virus struck, we see that for the most part bad metrics have gotten worse and good metrics have deteriorated. Despite there have been a significant recovery after COVID struck, the rise in inflation seems to have reintroduced an extremely negative sentiment across CFOs in the United Kingdom. The survey gives us a road map of how CFOs are starting to pull back and batten down the hatches and prepare for bad things to happen as inflation continues to linger high, as the Bank of England gets prepared to raise rates further and as war continues between Ukraine and Russia causing risks of more supply disruption and higher inflation to linger. There's almost nothing in this survey from which to take heart.

Europe is not just being roasted by global warming, extremely hot temperatures, and raging forest fires, but also by an extremely overheated inflation rate. The targeted HICP inflation rate for June rose by 0.7%, taking the year-over-year rate up to 8.6%. The core rate slowed in June, rising by 0.1%, after a gain of 0.5% in May, but it's up at a 3.7% annual rate year-over-year in June.

The headline inflation rate shows some cooling in its path as its 8.6% 12-month rate is at a 10.9% annualized rate over six months, then cools to a 6.5% pace over three months. The core rate, however, continues to accelerate from 3.7% over 12 months to 4.2% over six months, to 4.3% over three months.

The ECB at long last is getting ready to raise rates at this week's meeting. There is some speculation that there could even be a 50-basis point rate hike, not just a first-step 25-basis point rate hike. The Bank of Canada just hiked rates by 100bp; last meeting the Fed stepped its pace up to 75bp when 50bp had been expected. The ECB has been struggling with the issue of fragmentation which it's an attempt to deal with the disparate impact of inflation and rising interest rates across various European Monetary Union members. All eyes are going to be on the ECB this Thursday.

Clear, if mixed, inflation trends Inflation trends in the European Monetary Union are clear. Looking at the four largest EMU economies, the 12-month inflation rates range from a high of 10% in Spain to a low of 6.5% in France with Germany logging an 8.3% pace and Italy logging an 8.5% pace. The progression of inflation from 12-months to six-months to three-months over these countries shows mixed trends – but they are the same mixed trends across these four countries. There is acceleration from 12-months to six-months in all cases. Over six months inflation ranges from 11.9% in an annual rate in Italy and Spain to 9.5% annualized in France. However, over three months the inflation rate breaks lower in each of these countries, ranging between 9.7% in Italy to 5.3% in Germany. All these, of course, are clearly excessive rates and excessive compared to the 2% average that the ECB now aims at. Since the ECB is looking at some sort of (unspecified) average, it is likely that the higher 12-month inflation rates are more relevant for policy than the inflation rates calculated over short periods.

Core inflation trends Core inflation tells a slightly different story although it's not necessarily a story that is better; in some ways it is better and in other ways the story is worse. The story of core inflation is being told from lower levels of inflation than what we see in the headline. That much is good news. Over 12 months the inflation rate among the four largest EMU economies for either core or ex-energy inflation (ex-energy in the case of Germany) ranges from 3.5% in France to 5.4% in Spain. Over six months core inflation accelerates the same as with headline inflation. It accelerates in each country with the pace of inflation over six months annualized, ranging from 4.4% in Germany to 7.6% in Spain. But now we get to the part where things get worse rather than better. Over three months inflation accelerates in each of these countries. Inflation in Germany is the lowest at 4.7% while inflation in Italy is at a pace of 8.2%; inflation in France comes in at a 5.8% pace while Spain's rate is at a 7.8% pace.

Compares and contrast
Headline inflation in the EMU runs at 8.6% over 12 months and then decelerates to 6.5% over three months. The core inflation rate runs at 3.7% over 12 months but accelerates to 4.3% over three months. The levels of core inflation are more tolerable than for the headline, but the pattern for the core showing ongoing acceleration is more worrisome. These two measures leave the ECB with nowhere to hide.

A longer view
Also worrisome are the five-year results for inflation. The compounded five-year inflation rate as of June for the headline is 2.8%. Despite some persistent inflation undershooting before inflation jumped up, inflation has now become so strong in the recent months that the compounded inflation rate over five years has moved above a 2% pace. Core inflation, however, still fits inside of the objective of the ECB at a 1.6% pace. Looked at in terms of the four largest EMU members, each of them has a five-year average well above 2%. For Spain, the average is 3%; for Germany it's 2.9%; for France it's 2.5%; and for Italy it's 2.3%. However, the inflation rate for the core is still tame: German inflation excluding energy is up at a compound pace of 2.1% arguably at the borderline of acceptability. Spain logs a 1.7% pace, France logs a 1.6% pace, while Italy's pace for compounded inflation is 1.3%.

Excess inflation
Excess inflation is still largely being driven by energy as well as food components. When we exclude those two things and look at core inflation, it is better behaved; however, it is still over the line. Over these longer five-year periods, core inflation appears more suitable. But for how long with that be the case with inflation still running so hot?

ECB policy challenges
The ECB continues to have problems and questions with the outlook for energy in July still in flux. Brent energy prices measured in euros fell by 3.8% in June after rising 23% in May and 9.6% in April. Brent measured the same way rose at a 184% annual rate over the last three months. And there are ongoing concerns about what will happen with energy prices. U.S. President Joe Biden just got back from a trip to Saudi Arabia where he tried to convince the Saudis to pump more oil to help alleviate the stress on world markets. In the immediate aftermath of this trip, it doesn't sound like he was very successful, but time will tell what OPEC-plus will do.