Eurozone - Weakness under the surface
The eurozone economy grew by 0.1% qoq in 2022Q4, but we think that moderate contractions are on the cards for the next few quarters, as the impact of interest rate hikes will increasingly be felt. There will be at least one more 50bp rate hike by the ECB in March, but the risks are skewed toward additional hikes in the short term.
Eurozone GDP came in stronger than expected in 2022Q4, growing by 0.1% qoq versus the expectation of a modest contraction. That said, Ireland’s GDP is notoriously volatile and grew by 3.5% qoq. Excluding Ireland, eurozone GDP would have contracted slightly. Another temporary push factor for GDP in Q4 was a rebound in motor vehicle production (+14% qoq) and new car registrations (+12.5% qoq), following the easing of supply bottlenecks that had hampered the sector since the start of the pandemic. No details of Q4 GDP have been published yet, but it seems that private consumption and private investment contracted somewhat, whereas net exports and government spending contributed positively to growth.
Looking forward, we expect GDP to contract moderately during most of 2023. This will mainly result from monetary policy tightening by the main central banks, which is expected to have a stronger downward impact on global growth than the potential positive impact from China’s reopening. The impact of monetary policy tightening works with long and variable lags and we judge that most of the cumulative impact of past and upcoming rate hikes, and the tightening in financial and bank lending conditions, is still very much to be felt on the economy. Indeed, further evidence of the negative impact of interest rate hikes by the ECB on the eurozone economy was provided by the ECB’s Bank Lending Survey (BLS) for 2022Q4. Banks tightened credit standards for all types of loans sharply again in Q4 and expect to tighten them further in 2023Q1. The BLS also showed that loan demand by companies for fixed investment dropped lower again in Q4, while loan demand by households for house purchases fell to its lowest level since the start of the series in 2003.
Headline inflation fell to 8.5% yoy in January, down from 9.2% in December 2022 and a peak-level of 10.6% in October 2022. Core inflation was more sticky and stabilised at 5.2% yoy in January. We think that headline inflation will continue to drop lower in the coming months and be around 2% by the end of the year. Core inflation (excluding food and energy) is expected to be more sticky and decline more gradually. As a result, core inflation should be higher than the headline rate in the final months of this year. We see core inflation falling gradually towards 2% in the second half of 2024.
At its February meeting, the ECB hiked its key policy rates by 50bp and also pre-signalled another 50bp hike in March. We have maintained our forecast that the deposit rate will peak at 3%, implying that the March hike would be the final one and that rates will be kept on hold for a while after that. Meanwhile, we have pencilled in a pivot by year end, with rate cuts beginning in the fourth quarter. The risks to our view are skewed toward a more aggressive path on the 3-month horizon, although it seems likely that the pace of the hikes will be reduced to 25bp in case the central bank decided that rates should move further into restrictive territory.