Key views Global Monthly June 23

Macro

Eurozone – Q1 GDP was revised lower to -0.1% qoq (was +0.1% earlier). Growth in 22Q4 was also -0.1%, implying that the region has entered a recession. We think that weakness will continue and our base case sees ongoing moderate contractions in GDP during the rest of the year. Domestic demand will be hit by the interest rate hikes by the ECB and exports are limited by a slowdown in global growth. Core inflation seems to have peaked and should gradually decline during the rest of this year. It will be more sticky than headline inflation though, as parts of services inflation will probably continue to rise in the short term.

The Netherlands – Dutch GDP contracted by -0.7% qoq in 2023Q1. Most recent figures continue to show a slowing but resilient Dutch economy. Dutch GDP is expected to grow by 0.7% in 2023 (revised downward from 1.2%). Due to recessions in the eurozone and the US, external demand will be lower. Monetary headwinds will be increasingly felt over the course of the year. On the other hand, labour market tightness, government spending, and the resilience of household balance sheets are supportive of domestic demand. We expect inflation (HICP) to average 4.3% in 2023 and 3.4% in 2024.

UK – The inflation problem is getting worse, not better. While headline inflation is declining, core inflation has resumed its acceleration, with both April and May readings surprising significantly to the upside. Wage growth also continues to accelerate, posing upside risks to the medium term inflation outlook. With demand also showing signs of rebounding, the recent upside news raises the risk once again of a potentially deep recession triggered by a prolonged period of ultra-high interest rates.

US – We now expect a downturn to begin in Q4 2023. We have upgraded our 2023 growth forecast, but significantly downgraded our 2024 forecast. The expected weakness in 2024 reflects the later start to recession but also a more prolonged period of ultra-tight monetary policy. Headline inflation is expected to continue falling, but core inflation is likely to prove more sticky. There is significant uncertainty over where inflation will settle in the medium term given labour shortages and residual supply/demand imbalances in the economy. Inflation falling sustainably back to target hinges on a rise in unemployment over the coming year.

China – Following solid GDP/ activity data for Q1, data for April/May came in weaker than expected, showing that headwinds from a global slowdown and the property sector remain serious. We expect qoq growth to cool sharply in Q2, although yoy growth will surge reflecting the base effect from 2022. We cut our growth expectations for Q2, and our annual growth forecast for 2023 to 5.7%, from 6.0%. Meanwhile, the PBoC resumed piecemeal monetary easing, in line with our expectations, while more targeted fiscal support, including for real estate, is likely as well.

Central Banks & Markets

ECB – As expected, the ECB raised the deposit rate by 25bp in June. It also kept a hawkish policy stance and even appeared to have opened the door for rate hikes continuing past the Summer. Nevertheless, we are sticking to our view that the ECB will hike just once further in July, taking the deposit rate to 3.75%. This is because the ECB is likely to be surprised to the downside on both economic growth and inflation. As such, we think that by September, it will become clear to the Governing Council that it has done enough, and may even have overshot. A rate cut cycle still is likely to begin in December and continue during 2024.

Fed – The FOMC kept policy on hold in June, but the Committee made clear that its tightening campaign is not yet over. We expect the Fed to hike once more in July, with the risk tilted toward a further hike in September. We have also pushed back our expected start to rate cuts from December to March 2024. As such, we now expect a more prolonged period of highly restrictive monetary policy, with the fed funds rate likely to end 2024 at 3.50-3.75%. This is 75bp higher than our previous expectation, but still around 100bp below what the FOMC is currently signalling in its latest June projections.

Bank of England – The shock core inflation readings for April and May led the BoE to surprise markets with a 50bp hike, taking Bank Rate to 5.00%. We now expect a further two 25bp hikes at coming meetings, with it being a close call whether the MPC hikes by another 50bp in August. MPC decisions over the next few months will be highly sensitive to incoming data. We do not expect rate cuts until next May, and there is a significant risk that rate cuts get delayed even further.

Bond yields – The hawkish tone from central bank meetings last week led to a deeper inversion of the yield curve. However, given our macro and central bank outlook, we judge that the market will retrace part of the repricing in the coming months. We forecast lower US and Euro rates in H2 2023, with both the Treasury and Bund curve inversion peak now likely behind us. As such, we think both curves are set to bull-steepen for the rest of the year and throughout 2024. Indeed, as the economy weakens and inflation continues to slowdown, the market is likely to start repricing rate cuts for 2024, pushing short-term rates lower.

FX – We have downgraded our forecasts for EUR/USD. First, we no longer have a rate cut for the Fed this year and fewer total rate cuts in 2023-2024. This is a positive for the US dollar. Second, if the ECB starts cutting rates already in December the euro will suffer. Third, aggressive rate cuts by the ECB in 2024 will put more downward pressure on the euro than Fed cuts will on the dollar. This is because markets have already anticipated large rate cuts by the Fed but not by the ECB. Fourth, the speculative positions in the euro are extremely large. Our new forecasts are 1.08 (end 2023) and 1.05 end 2024.

This article is part of the Global Monthly of 26 June 2023