The conclusion of the month of August marks a challenging period for investors, characterized by heightened difficulties in the eurozone due to an unexpectedly pronounced decline in business activity. Despite the release of official data indicating a more substantial decrease in German retail sales in July, investors exhibited indifference.

Over the past year, the European Central Bank (ECB) has executed a rapid succession of rate hikes, achieving historically unprecedented levels in more than two decades. However, the onset of stagnant growth coupled with rapidly deteriorating sentiments among both businesses and households has ignited a fervent discourse regarding the necessity and extent of further policy tightening.

Investor attention remains intently focused on the ECB’s stance on interest rates, mirroring the endeavour of the Federal Reserve, as both central banks strive to curtail inflation through tighter financial conditions. In late July, the ECB signalled its willingness to maintain rates at their current level during the upcoming monetary policy meeting in mid-September. Nevertheless, robust inflationary data could potentially propel the central bank toward a more hawkish standpoint.

Contrary to expectations for a reduction to 5.1%, overall inflation within the euro-sharing nations remained constant at 5.3% in August. This was driven by a notable surge in energy costs during the month, as revealed by Eurostat data on Thursday. Nonetheless, a fundamental gauge that excludes the volatile components of food and energy exhibited the anticipated easing from 5.5% in July to 5.3% this month, despite minimal movement in services inflation.

Financial markets revised the likelihood of a September rate hike from approximately 50% earlier in the week to 33%; however, expectations suggest that another rate hike may still transpire within the year, possibly in October or December.

Simultaneously, the rapidly deteriorating economic landscape will offer advocates of a cautious approach within the ECB’s Governing Council substantial rationale to advocate for a pause in tightening measures. This intricate scenario implies that the ECB’s deliberations will remain unsettled until the presentation of new economic projections by the staff in the days leading up to the meeting scheduled for September 14.

Proponents of a cautious approach argue that the pace of growth has substantially waned, and without significant stimuli for a resurgence, the region’s economy, which has remained stagnant over the past three quarters, could potentially slide into a recessionary phase.

In contrast the hawks see such a slowdown as desirable, particularly if it were to cool down the very tight labour market, because price pressures remain elevated and could lead to inflation becoming stuck at above the ECB’s 2% desired target.

Source: TradingView

The rising inflationary and recessionary fears have put the DAX 40 index into test. Sticky inflation is exerting pressure to the ECB to deliver more rate hikes, while the deteriorating macroeconomic backdrop is testing the theory of rate hikes tackling inflation. The rally in the benchmark German index lost momentum in August and is likely to be capped for the year, as stock prices are too high relative to earnings and recession fears mount. The deteriorating Relative Strength Index indicator conditions suggest that the rally is running out of steam and further consolidation between 15,460 and 16,500 is likely in the next few months.