Market outlook
Update: 9 February
Risk statement
As we are mainly active in banking, insurance and asset management, we are exposed to a number of typical risks for these financial sectors such as – but not limited to – credit default risk, counterparty credit risk, concentration risk, movements in interest rates, currency risk, market risk, liquidity and funding risk, insurance underwriting risk, changes in regulations, operational risk, customer litigation, competition from other and new players, as well as the economy in general. KBC closely monitors and manages each of these risks within a strict risk framework, but they may all have a negative impact on asset values or could generate additional charges beyond anticipated levels.
At present, a number of factors are considered to constitute the main challenges for the financial sector. These stem primarily from the impact of the war in Ukraine, not just directly, but even more so indirectly due to the resulting increase in energy and commodity prices and supply-side shortages, which were already stressed following the coronavirus pandemic. This has led to a surge in inflation, resulting in upward pressure on interest rates, reduced liquidity and volatility on financial markets, lower growth prospects (or even a recession) and some concerns about the creditworthiness of counterparties in the economic sectors most exposed. These risks affect global, but especially, European economies, including KBC’s home markets. Regulatory and compliance risks (including capital requirements, anti-money laundering regulations and GDPR) also remain a dominant theme for the sector, as does enhanced consumer protection. Digitalisation (with technology as a catalyst) presents both opportunities and threats to the business model of traditional financial institutions, while climate-related risks are becoming increasingly prevalent. Cyber risk has become one of the main threats during the past few years, not just for the financial sector, but for the economy as a whole. The war in Ukraine has again increased vigilance in this area. Finally, we have seen governments across Europe taking additional measures to support their budgets via increased tax contributions from the financial sector and their citizens and corporate sector (by, for instance, implementing interest rate caps or loan repayment moratoria).
We provide risk management data in our annual reports, quarterly reports and dedicated risk reports, all of which are available at www.kbc.com.
Our view on economic growth
After quarter-on-quarter growth of 0.8% (non-annualised) in the third quarter, the US economy also expanded in the fourth quarter, growing by 0.7% quarter-on-quarter (non-annualised) mainly on account of inventory build-up and private consumption. While we expect further, albeit more moderate, growth in the first quarter of 2023 (+0.2%), a mild contraction of the economy is still likely in the second and third quarters, with growth falling by -0.1% in both quarters (i.e. a technical recession). This will be largely driven by ongoing high inflation and a further tightening of financial conditions as a result of the Fed’s monetary policy.
Meanwhile, fourth quarter growth in the euro area was slightly positive at 0.1% quarter-on quarter (compared to +0.3% in the third quarter), thereby avoiding a contraction and the possible start of a technical recession. The euro area economy is expected to stagnate in the first quarter of 2023, due mainly to the impact of the lagged effects of the energy crisis and the tightening of monetary policy.
In the fourth quarter of 2022, economic growth in Belgium remained slightly positive (+0.1%), but is expected to stagnate in the first and second quarters of 2023, thus narrowly avoiding a technical recession. On the other hand, the Czech economy is going through a technical recession. Negative growth of -0.2% quarter-on-quarter in the third quarter of 2022 was followed by -0.3% in the fourth quarter. Moreover, the economy is expected to contract by 1% in the first quarter of 2023.
The main risk to our short-term outlook for European growth relates to a renewed escalation of the energy crisis that gives rise to additional inflationary pressure, and uncertainty regarding the timing and impact of monetary policy tightening by the ECB and, more broadly, by the Fed. Other risks include vulnerability caused by elevated real estate valuations and high levels of debt in the context of tightening financing conditions worldwide.
Our view on interest rates and foreign exchange rates
To fight increasing inflationary pressure, the Fed continued to raise its policy rate in the fourth quarter, hiking it by 75 basis points in November and 50 basis points in December. The Fed continued its hiking path in early February 2023 by 25 basis points to the current target range of 4.50%-4.75%. We expect the Fed to continue raising its policy rate in the remainder of the first and second quarters of 2023. Moreover, the ongoing run-down of the Fed’s balance sheet (‘Quantitative Tightening’) is contributing to a tightening monetary policy stance. Meanwhile, the ECB also raised all of its policy rates, increasing them by 75 basis points in November and 50 basis points in December. The ECB depo rate currently stands at 2.50% after the latest rate hike of early February 2023. We expect the ECB to continue hiking its policy rates. In line with its guidance following its December 2022 policy meeting, the ECB will start gradually running down its APP portfolio from March 2023 on
On balance, 10-year US government bond yields ended a volatile fourth quarter broadly unchanged. In the same period, German 10-year yields rose on balance by about 50 basis points, causing the US-German yield spread to narrow. The direction in which the yield moved was largely synchronous during the quarter, but the upward movement was stronger for the German yield as a result of the market expecting the ECB to adopt a more hawkish stance.
During the fourth quarter, the euro (EUR) recovered sharply against the US dollar (USD), moving from below parity to 1.07 USD per EUR at the end of 2022. This was mainly the result of the expected increase in interest rate support from ECB policy and the start of a general decrease in global risk aversion. The decreasing risks for the economic outlook for the euro area stemming from the sharp decline in energy prices and lower recession risks also played an important role. For the first and second quarters of 2023, we expect the optimistic market sentiment to pause, causing the exchange rate of the EUR to correct to about 1.03 USD per EUR, before gradually appreciating again in the second half of 2023.
During the fourth quarter, the Czech koruna (CZK) appreciated against the EUR, moving from about 24.55 to about 24.12 CZK per EUR. Improved global risk sentiment and targeted forex interventions by the Czech National Bank (CNB) supported the CZK’s exchange rate. The CNB left its policy rate unchanged at 7%, which we expect to be the peak level in the current tightening cycle. The absence of further expected rate hikes and the phasing out of targeted forex interventions in preparation for the first rate cut expected in the fourth quarter is likely to cause the CZK to weaken against the EUR in the second half of 2023.
In the context of high inflation, the National Bank of Hungary (NBH) kept its base rate at 13%. This is expected to be the end of its tightening cycle with respect to the base rate. On balance, the exchange rate of the Hungarian forint (HUF) against the EUR appreciated sharply from about 422 to about 401 HUF per EUR during the fourth quarter of 2022. Like the exchange rate of the CZK, a major driver was the improvement in global risk sentiment, also supported by higher interest rates on specific short-term liquidity instruments. Nevertheless, the exchange rate of the HUF was still significantly weaker against the EUR than at the beginning of 2022.
For more detailed analyses and data, please refer to KBC Economics.
Disclaimer: the expectations, forecasts and statements regarding future are based on assumptions and assessments made when drawing up this text. By their nature, forward-looking statements involve uncertainty. Various factors could cause actual results and developments to differ from the initial statements. Moreover, KBC does not undertake any obligation to update the text in line with new developments.