Is this ECB lady finally for turning on monetary policy? Mixed quarterly earnings and gathering central bank hawks again adds to equity and bond market skittishness and another positive outlook for the Irish residential property market. All these stories and more are covered in this week’s insights update from BlackBee.
Will the European Central Bank (ECB) actually increase interest rates in 2022? That was the intriguing question investors grappled with following last week’s monetary policy meeting at the Bank. ECB President Christine Lagarde certainly talked the talk anyway, commenting that inflation risks were “tilted to the upside” while refusing to reiterate her previous comments that an interest rate increase this year was “very unlikely”. This led to a flurry of market activity with bond yields across the Eurozone rising sharply and the euro moving swiftly higher versus the US dollar. Our chart of the week this week shows that investors quickly priced in two rate hikes across the Euro zone by the end of this year.
In our 2022 outlook we questioned whether the ECB would increase interest rates, arguing that the unbalanced recovery in the region might hold it back from doing so. It is clear from yesterday’s comments that some in the Governing Council would like to see an adjustment in policy sooner rather than later, however. Following on from this, the ECB’s March staff macroeconomic forecasts will be crucial if a rate hike this year is set to become a reality. If the forecasts point to a stable economic recovery and continued higher than expected inflation (i.e. not moderating as much as the Bank would like to see), then that will tend to validate moves to tighten.
Before this however, investors will need to see ECB bond purchases draw to a close and even then the ECB may wish to approach interest rate increases slowly. So, if interest rates in the Euro zone are to rise in 2022, it may be towards the back end of the year. In our view the scope for monetary tightening across all the main central banks is weaker now compared to previous rate hiking cycles, chiefly because of weaker long-term growth dynamics and higher debt levels across the world. In an ECB context that may mean interest rates may struggle to get much higher than 2% in this cycle compared to previous peaks of over 4%.
Global equity markets remained choppy last week against the backdrop of the greater rates volatility around the world as the ECB took a hawkish tilt and the Bank of England again increased interest rates. On the earnings front there were also a number of mixed quarterly updates from companies like Amazon, Meta (parent of Facebook), Snap and Paypal with a particularly poorly received set of Meta results behind a significant 27% share price fall on Thursday. On the whole though US first quarter earnings still continue to track slightly above earnings expectations at the beginning of the quarter, a pattern which investors will want to see more of if stock markets are to stabilise and ultimately build on their 2021 performance.
Government bond markets continued to suffer some pain last week due to the combination of more hawkish central bank guidance, as well as some positive economic data points which again reinforces the likelihood of tighter monetary policy. The ECB monetary policy meeting we noted earlier translated into a jump higher in yields across the region with many core economies like Germany and France seeing 10-year yield increases of up to 20 basis points. All of this came on top of the Bank of England (BoE) hike on Thursday where four BoE committee members actually voted for a 50-basis point hike, underpinning its rate hiking credentials. The overall positive tone of economic data through the week also put government bonds under pressure, particularly the US January employment report which showed the US economy created 467,000 jobs in the month – a massive beat compared to the expectations of only 125,000.
Commodity indices moved higher again last week, thanks in the majority to further increases in oil prices. Prices moved higher even in the face of OPEC+ agreeing to raise output by a further 400,000 barrels per day from March onwards. Another gain in oil prices even in spite of this says that increases in supply are insufficient to meet the increases in economically driven oil demand. At $90+ per barrel now we believe oil is pushing close to levels where it begins to crimp economic demand. In short, more supply is required now to ensure oil doesn’t begin to pressure the global economic recovery.
Forestry – State plans to issue 5,200 planting licenses this year as log imports rise by 75% in 2021
In a recent edition of our Insights we commented that the Irish forestry industry has the potential to produce enough timber to displace roughly 6% of our total emissions, but, in order to do this, we must reduce the substitution costs between timber and its alternatives in the areas of construction, packaging and energy by increasing domestic supply.
Minister Hackett’s announcement last week that the Department of State was aiming to issue 5,200 planting licenses this year is a step in the right direction. Last year’s conversion rate (licenses issued to hectares planted) of less than 64% was too low and undoubtedly contributed to the 75% increase in timber imports over 2021. Minister Hackett hopes that the increase in licenses being issued, including a targeted 50% increase in private licenses across planting, felling and road licenses will improve this conversion rate and increase the supply of domestic timber, thereby increasing the potential sequestration of our forests and reducing Ireland’s reliance on timber imports. There is recent evidence to suggest it will work, as the increase in felling and road licenses in the final quarter last year coincided with a fall of Scottish log imports.
Commercial Real Estate – Frank Knight issues positive 2022 outlook for residential sector
Last week Frank Knight unveiled its residential market outlook for 2022 highlighting the sector’s continued popularity with investors. In 2021 over 42% of total investor spend was in the residential property with spending on the multi-family housing segment accounting for 83% of this. Similar to our own views, Knight Frank believes this trend will continue this year supported by a growing Irish population and sizeable job-creation across 4 specific sectors; 1. pharmaceutical, 2. Financial, 3. ICT, and 4. Professional, Scientific and Technical. Another factor which will drive residential investment demand is tight supply, an on-going structural issue of the Irish housing market, with capacity further reduced over the last year as COVID slowed construction activity. From a valuation perspective it feels that competitive investor bidding and tight supply are expected to compress yields but will not reduce the flow of capital into the Irish residential investment market, especially as Dublin is now viewed as a tier one city.