Goldman Sachs: Out Of Negative Rates, Into A Growth Crunch

Goldman Sachs note that “ECB officials responded to rising inflation expectations with a surprise 50bp rate hike, flanked by a new “Transmission Protection Instrument” to serve as a backstop for sovereign credit amid higher policy rates. While we continue to think that exiting negative rates could be a significant boost for the Euro over the medium term, the rest of the news flow from last week underscores the challenges facing the currency, and indeed the need for the backstop to be in place so early in the normalization process in the first place. The end of the negative rate era is marked by a clear slowdown in spot activity data (including a rather negative orders-to-inventories mix in the flash PMIs for July), and activity will likely need to be restricted even further despite the partial return of Russian gas flows. Weaker economic activity and the cost of living crunch has helped contribute to significant political uncertainty especially in Italy, which also seems likely to contribute to a difficult investment environment over the next few months. Overall, while the end of the negative rate era should be an important step for the Euro over time, the growth outlook has deteriorated materially over the course of this year, and we think this accounts for much of the recent slide in EUR/USD, so domestic factors will likely continue to weigh on the single currency in the near term. We will closely monitor capital flows in the weeks and months ahead, but it will likely require a brighter investment outlook, in combination with higher policy rates, to make a convincing turn away from parity.”