Key views Global Monthly June 2022
The post-pandemic recovery is being hampered by the surge in inflation, and increasingly, the prospect of energy shortages in Europe. 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 is expected to start raising rates in July, with rates moving into positive territory by September. Europe will also continue to feel the global spill-over effects of tighter US monetary policy, pushing bond yields higher, equity markets lower, and ultimately dampening growth.
Macro
Eurozone
GDP is expected to grow by 0.3-0.4% qoq on average throughout 2022Q2-Q4, but a sharp slowdown is expected moving into 2023. By then, consumers will have spent most of the savings they accumulated during the pandemic, while labour market conditions should worsen. Also, temporary catch-up effects in industrial production and fixed investment will fade and domestic spending will slow down due to the interest rate hikes by the Fed and ECB, which tighten financial conditions. Inflation rose to 8.1% in May and could rise further in coming months.
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 and possible gas cut-off however is weighing strongly on the growth outlook. We expect Q2-Q3 growth to be modest, afterwards growth will slow down significantly. The labour market remains a bright spot with unemployment falling due to very strong labour demand with a record 133 vacancies per 100 persons unemployed.
UK
Inflation held at over 9% in May 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. In 2023 we expect the economy to stagnate, with a technical recession possible. The labour market remains strong for the time being, and inflation appears to be triggering higher wage growth.
US
Growth appears to have slowed significantly in June according to the PMIs, but demand indicators overall have been very strong in Q2. Following a rebound in growth, we expect underlying demand to slow significantly in H2 and into 2023, as the decline in real incomes and interest rate rises begin to bite. Soft demand is likely to push the unemployment rate higher, although supply-side volatility means the economy might escape a technical recession. Risks to inflation continue to be to the upside, potentially requiring even bigger interest rate rises to bring back down.
China
May data show a recovery from the March/April lockdowns related slump.This rebound is led by the supply side, with ongoing strict Covid-19 policy leaving its mark on consumer confidence and consumption. We still expect momentum to pick up in 2H-22, assuming the gradual reopening to continue and targeted fiscal support, cautious monetary easing and a relaxation of macroprudential rules (including for real estate) to filter through. Still, given the recent data and our changed US/Fed and EZ/ECB views, we cut our 2022 growth forecast to 4.2% (from 4.7%).
Central Banks & Markets
ECB
Following its June meeting the ECB announced the end of QE and signalled a first 25bp rate hike in July. It seems that a 50bp hike is on the cards for September. Subsequently, we expect a 25bp hike during every Governing Council meeting until February 2023, when the discount rate should reach 1.00% (up from -0.50% now). We have not pencilled in any rate hikes after that, which mainly reflects the fact that economic growth is expected to slow down considerably in 2023.
Fed
Given persistently elevated inflation in the US, and upside risks to the outlook, we expect the Fed to hike rates a further 75bp in July. Thereafter, we expect two more 50bp hikes and two 25bp hikes taking the upper bound of the fed funds rate to 4% by February. Subsequently, 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 begun unwinding its balance sheet in June, initially at a $47.5bn monthly pace, doubling to $95bn from September.
Bank of England
The growing risk of a wage-price spiral in the UK triggered a hawkish pivot by the MPC at the June policy meeting. We expect now expect a 50bp hike in August, and Bank Rate to peak at 2.5% by year end. We think that by later this year, the economy should have sufficiently weakened to drive a rise in unemployment and a cooling in wage growth. Combined with a broader fall in inflation in the first half of next year, this could raise the prospect of the MPC reversing course and cutting rates to support growth, perhaps in H2 2023.
Bond yields
Based on our updated Fed and ECB call, we expect another sell-off in both Treasury and German bonds in the coming months. We expect the 10y US Treasury yield to peak in Q3 this year at 3.9%. Similar path for the 10y Bund yield due to the US spill-over effects pushing Bund yields higher. However, we expect a significant drop in yields starting in Q4 where we expect markets to price out multiple rate hikes as economic growth is expected to slow down. Safe-haven demand expected to put further downward pressures on Bund yields next 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.