European equities started off the New Year with a bang, as investment sentiment improved markedly on the back of slightly positive data. Further anticipation of relative tightness drove the Euro higher, the single currency gained 1.48% against the Dollar over the month of January, and the STOXX 600 index went 6.67% higher (8.20% in US$ terms)

Economic data continued to improve in January, notably in sentiment across the board. More importantly, inflation data have showed encouraging signs, headline figures fell 0.4% MoM, largely driven by the fall in energy prices. The much watched core inflation has also recorded a fall MoM, the fall helped improve consumer and business sentiment and raised hopes for the sticky inflation to gradually ease. On the other hand, the economy has performed better than expected, and the slowdown could be shallower than originally thought. That said, this increases the risk of and extended high inflation.

In response, the European Central Bank further raised interest rates for another 50 bps, and the Bank will also start its quantitative tightening by March. ECB President Christine Largarde said the Bank will continue ‘raising interest rates significantly at a steady pace’, which was unusually clear and hawkish. The Bank’s stance underlines the uncertain nature of inflationary pathway for the year, and further tightening will put extra pressure on valuations and the real economy. With the recent rally, we see extra downside risk in the market arising from the uncertainty. Henceforth, we remain conservative on the market, and would recommend underweighting in the short term.