Key views Global Monthly April 2023
The easing energy crisis in Europe is leading to more shallow expected recessions in the eurozone and UK. Consumption will continue to be weighed by falling real incomes, and the impact of monetary tightening is being increasingly felt – with housing markets clearly correcting on the back of the surge in mortgage rates. Key near-term risks come from the tightening bank lending standards, but strong financial buffers could blunt the impact of this. China’s exit from Zero Covid is offsetting the slowdown in advanced economies to some extent. While headline inflation has begun to trend lower, stubborn underlying inflationary pressures means the Fed, ECB and BoE are likely to continue raising rates in the near term.
Macro
Eurozone – Incoming data indicate that eurozone GDP contracted slightly in 2023Q1. The impact of past and upcoming interest rate hikes will increasingly be felt. We expect GDP to contract moderately during most of 2023. Underlying inflation has not eased yet and wage growth accelerated faster than expected in Q4. Headline inflation will fall rapidly this year due to drops in wholesale energy and food prices as well as dissipating supply chain bottlenecks. Core inflation will be more sticky in the short-term, but should also ease going forward.
The Netherlands – Dutch GDP is expected to grow by 1.2% in 2023 (from 4.5% in 2022). We expect external demand to be lower due to recessions in the eurozone and US. Monetary headwinds will be felt over the course of the year. Despite risks to the medium-term outlook, recent activity data show that short-term risks are tilted to the upside. Consumption has proven to be resilient despite the loss of purchasing power. The labour market is expected to soften, but overall tightness is here to stay. We raised our inflation forecasts (HICP) to 4.6% in 2023 and 4.1% in 2024.
UK – While the easing energy crisis is softening the blow to household real incomes, the tax burden is set to rise significantly over the coming year. The UK may dodge a recession but the economy is expected to remain weak. The medium term outlook will critically depend on the evolution of labour productivity which remains weak. CPI and wage inflation has rebounded, raising the risk that inflation settles at above target levels. The risk to inflation is skewed to the upside because of a structural shortage of workers and public sector unrest.
US – The economy is clearly slowing in response to higher interest rates, but at a snail’s pace. We expect consumption to contract in Q2 as falling real incomes and reduced optimism over the outlook hit spending. Investment is also expected to remain weak on tighter credit conditions. Inflationary pressures have rebounded, while labour hoarding persists. We still expect the NBER to declare a recession later this year. Inflation is expected to continue falling, but there is significant uncertainty over where inflation will settle given labour shortages and residual supply/demand imbalances in the economy.
China – The reopening rebound, led by consumption/ services, is firming. Real GDP growth accelerated in Q1, while activity data for March on balance point to a stronger growth momentum, with the property sector recovering. Also taking into account the upward revision for Q4-22 and related spill-overs, we raise our 2023 growth forecast to 6.0% (from 5.2%). Partly reflecting the stronger 2023 base, our 2024 growth forecast is now 5.0% (was 5.2%). Main risks to the economy are the downturn in global demand and ongoing tensions with the US on tech/Taiwan/Russia.
Central Banks & Markets
ECB – The ECB raised the deposit rate by 50bp in March. It seems that its bias is still towards further rate hikes, at least if its baseline scenario plays out. Our baseline scenario sees the deposit rate peaking at 3.75% before a rate cut cycle begins in December and continues during 2024. Our base scenario is for a 50bp hike in May and a 25bp hike in June, but the risks are tilted towards 25bp in May and two more 25bp hikes in June and July. If financial market stress and worries about banks were to flare up again, the ECB would probably use other instruments, instead of amending its rate policy in first instance.
Fed – The FOMC raised the fed funds rate by 25bp in March. We expect another 25bp hike in May, with a risk of further hikes if tighter lending standards prove short-lived. Our base case is that by December, the Fed will be ready to start pulling back from the current highly restrictive policy stance. Following an initial 25bp cut, we expect the Fed to cut 25bp at each of the eight meetings in 2024, taking rates back to near neutral levels by end-2024. The risk is tilted towards rates staying higher for longer, given the persistence of underlying inflationary pressure.
Bank of England – Recent upside surprises to wage and inflation data means the BoE is likely to hike once more in May, taking Bank Rate to 4.50%. MPC decisions over the next few months will be highly sensitive to financial market developments and incoming data. In our view, the economic weakness that is evident in the activity and employment data will start to exert downward pressure on wage growth as 2023 progresses. However, risks currently are tilted towards a higher peak in rates, and a later start to rate cuts (currently expected from Q4 onwards).
Bond yields – Given our macro and central bank outlook, we judge that the rate hiking cycle is approaching its end. The Fed is expected to peak in May and the ECB in June before both start cutting rates end of 2023. As such, we judge that the Treasury and Bund curve inversion peak are now behind us. We think both curves are set to bull-steepen for the rest of the year with the 2s10s spread expected to steepen by as much as 100bp for the Bund and by 70bp for the UST as we enter 2024. Indeed, the steepening path already started in the US on the back of this banking turmoil in March.
FX – EUR/USD tested the important level of 1.10 but moved below again. This was mainly because expectations about monetary policy of the Fed and the ECB moved more in our direction. We think that it is difficult for EUR/USD to break and stay above 1.10 in the current environment. We keep our our EUR/USD forecast for the end of 2023 and 2024 at 1.10 and 1.16 respectively. We foresee a higher EUR/USD in 2024 because of the larger amount of rate cuts we expect for the Fed compared to the ECB in 2024.