This week, we learned that Euro-zone inflation hit a new all-time high.
The May CPI grew by 8.1% compared to the same month in 2021, exceeding market forecasts of 7.8%. That far exceeds the European Central Bank’s inflation target of 2%. Even May’s month-on-month CPI growth of 0.8% and the core inflation print of 3.8% were above their respective median estimates.
The main factors that are explaining this rise in inflation are supply chain problems and the war between Russia and Ukraine, which are translating into soaring commodity prices.
How are these macroeconomic figures impacting European stocks?
These red-hot consumer prices is putting pressure on the European Central Bank to act more aggressively to control it.
It is important to remember that the euro zone has its interest rate still rooted in negative territory at minus 0.5%. The ECB is the only major central bank that has not yet acted to tighten monetary policy, though that is about to change in the near future.
ECB President Christine Lagarde has mentioned that its benchmark rate is expected to rise by 25 basis points at each of the July and September policy meetings. The main concern is that these hikes could result in a significant slowdown in the economy. In essence, policymakers have an unenviable task of quelling rising inflation, at the expense of slowing down the economy, with the risk of even perhaps triggering a recession.
Overall, equities do not like the thought of interest rates going higher, considering the prospects of a slowing or contracting economy.
Stoxx 50 attempts to break out of multi-month downtrend
Stock markets on the continent have largely followed the global selloff, with major European indices down by double-digits so far this year. The Stoxx 50 has fallen by more than 18% so far this year, having twice met the criteria for a ‘bear market’ (which is a 20% drop from its recent high): once in March and the other episode in May.
In such scenarios, stock markets are quick to incorporate the gloomy economic information, which is why they have fallen so sharply in the first half of the year, discounting a more complex scenario with lower growth and inflation remaining persistently higher.
Looking at the Stoxx 50 chart we can see that the index is looking to break the downtrend that started in November last year when it reached a high of almost 4400 points. From there, it dropped by just over 1000 points through March, though any recovery since has been hampered by the downward trendline.
To be fair to European equity bulls, this index has managed to post higher highs and higher lows since May, with this index trading around its 50-day simple moving average at the time of writing. Stronger support at this key moving average, coupled with the downward trendline from November’s peak transforming from a resistance to a support level, may serve as a solid base to extend this rebound.
If this index an surpass its most recent cycle high of 3847.4, stock bulls could be looking for a first target at the April cycle high of 3955.7, after which a break above the psychologically-important 4,000 mark could bring the March peak of 4028.1 into focus.
However, should these key technical support levels (50-SMA and downward trendline) be found wanting, then the Stoxx 50 may return to its downtrend that has persisted since November, driven by fears that the ECB has to become even more aggressive and trigger larger rate hikes in order to quell record high inflation.