Key views Global Monthly May 2022
The post-pandemic recovery is being hampered by the surge in inflation, the Russia-Ukraine conflict, and China lockdowns. Consumption growth is being weighed by the biggest fall in real incomes in decades, while industry faces headwinds from higher commodity prices and an intensification of supply bottlenecks. We still expect inflation to decline this year, but the jump in commodity prices and supply disruptions is delaying this. We expect energy prices to remain high over the next few years, with sanctions on Russia triggering a lasting trade realignment. Upside inflation risks mean the Fed is likely to continue raising rates rapidly at coming meetings. The ECB has signalled its intent to normalise policy, and we now expect rates to start rising in July. Europe will also continue to feel the global spill-over effects of tighter US monetary policy over the coming year, pushing bond yields higher, equity markets lower, and ultimately dampening growth.
Macro
Eurozone
GDP expanded by 0.3% qoq in Q1, mainly due to a rebound in services sector activity after lockdowns. Goods consumption and fixed investment currently are restrained by supply shortages. After a weak Q2, growth should pick up temporarily in 2022 H2 as supply bottlenecks ease and consumers spend excess savings. By the end of the year growth should slow down noticeably, falling below the trend rate in 2023. Inflation stabilised at 7.4% in April. It will remain elevated for a while, but will start declining from the middle of 2022.
Netherlands
First quarter growth in 2022 was flat, primarily due to the lockdown and the end of pandemic support measures. For Q2 we expect positive growth driven by private consumption. The war in Ukraine however is weighing on the growth outlook. While Q2-Q3 growth will be modest but positive, we expect Q4 growth to be flat. We expect the drag on growth stemming from inflation to fully materialise in the second half of 2022. The labour market continues to perform very well with a record 133 vacancies per 100 persons unemployed.
UK
Inflation surged to over 9% in April following the rise in the household energy cap by Ofgem. At the same time, growth indicators remain broadly weak, as the inflation hit to real incomes weighs heavily on consumer confidence. We expect this to drive a contraction in the economy in Q2, before growth recovers (albeit modestly) in the second half of the year. The labour market remains strong for the time being, with the vacancy to unemployment ratio continuing to rise, and wage growth accelerating. As the year progresses we expect the labour market to weaken.
US
Supply bottlenecks in Q1 led us to lower our GDP forecast for 2022 to 2.7% from 3.1% previously. Demand remains strong overall, despite the necessary cooling in goods consumption. There is still significant room for the services sector to recover, and we expect this to continue, albeit the pace of recovery is being weighed by the inflation hit to real incomes and – increasingly – tighter monetary policy. Inflation continues to be the biggest risk to the outlook. Services inflation accelerated in April, reflecting pass-through from elevated wage growth.
China
The broadening of lockdowns in March/April is making itself felt. April data were even weaker than in March, with domestic supply bottlenecks adding stress to global supply chains. Nationwide lockdown intensity started to ease in recent weeks. We expect a gradual reopening, within the framework of strict ‘dynamic clearing’. Still, risks remain as the trade-off between pandemic control and safeguarding growth becomes more challenging. We adjusted our near-term growth forecasts, and have cut our annual growth forecast for 2022 to 4.7%, from 5.0%.
Central Banks & Markets
ECB
The ECB has become more worried about inflation expectations. We have brought forward our expectation for the first rate hike from September to July, and now expect 25bp hikes in both July and September. After the deposit rate reaches zero in September, we expect policy rates to subsequently remain on hold for a while. This reflects that we expect economic growth to be sub-trend during 2023. Also, headline inflation will likely be on a significant downward trend from early next year.
Fed
Given persistently elevated inflation in the US, and upside risks to the outlook, we expect the Fed to continue hiking rates in 50bp steps in June and July. Thereafter, we expect 25bp hikes until the Fed reaches our estimate of the terminal rate of 2.5-2.75% in December. Thereafter, we expect the Fed to pause, assuming inflation is moving back towards its 2% target. Risks are to the upside, both in the rate hike pace and in the terminal rate. The Fed will begin unwinding its balance sheet in June, initially at a $47.5bn monthly pace, doubling to $95bn from September.
Bank of England
The MPC hiked a further 25bp at its May meeting, but the vote split and minutes showed a heavily divided Committee, reflecting the tight-rope the central bank is walking between keeping inflation expectations well anchored and preventing the economy from sliding into recession. We expect two further 25bp hikes, taking the policy rate to 1.5% by August. Thereafter, we expect the BoE to pause, as the risk of recession begins to weigh more heavily in policy deliberations than the risk of a drift higher in inflation expectations.
Bond yields
Both the US and the eurozone markets are well advanced with pricing in an aggressive rate hike cycle by the Fed and the ECB. We judge that markets are running ahead of themselves and expect a repricing of central bank hikes downwards in both the US and the Eurozone. This would in turn result in lower euro rates as well as US rates. Indeed, we expect the 10y US Treasury yield to drop from around 2.9% at the time of writing to 2.7% during the course of this year.
FX
The deterioration in investor sentiment initially resulted in investors taking some profit on US dollar longs. However, they later bought dollars again when sentiment deteriorated even further. We think that the upside for the US dollar versus the euro is limited, barring sharp risk off periods or even more aggressive rate hikes by the Fed. Going forward, more Fed rate hikes will only be a US dollar positive so long as investors don’t fear a sharp slowdown or a recession in the US. We expect more weakness on sterling due to the deterioration in the economic outlook.