Key views Global Monthly May 2023
The global economy is sending mixed signals of late, with some clear signs of recession contrasting with other signs of resilience. The impact of monetary tightening is being increasingly felt, with credit conditions pointing to looming recessions, while the German economy already is in recession. Key near-term risks come from the tightening bank lending standards in advanced economies, and the US debt ceiling impasse. 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 ECB and BoE are likely to continue raising rates in the near term, while the Fed is expected to maintain a tightening bias.
Macro
Eurozone – Eurozone GDP grew by 0.1% qoq in 2023Q1, whereas we had expected a moderate contraction. Still, incoming data and survey results for March-May indicate that moderate contractions in GDP during Q2 and the rest of the year are still on the cards, as domestic demand is hit by past and upcoming 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 also be felt over the course of the year. The domestic economy remains resilient due to labour market tightness, government spending, and the resilience of household balance sheets. We have changed our inflation forecasts (HICP) to 4.3% in 2023 and 3.4% in 2024.
UK – The easing energy crisis is softening the blow to household real incomes, helping the economy to dodge a recession, but the outlook remains weak due to tight monetary policy and a rising tax burden. Underlying inflationary pressure is exceptionally high, though there are some early signs that wage growth may be peaking. With rates expected to stay higher for longer, we now expect a prolonged period of stagnation. Even this may not be enough to bring inflation sustainably back to the BoE’s 2% target.
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, while spending cuts to raise the debt ceiling will become a further headwind. 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.
Central Banks & Markets
ECB – As expected, the ECB raised the deposit rate by 25bp in May – a slowdown from the earlier 50bp hikes. Also, the ECB plans to discontinue reinvestments under the APP as of July 2023. The ECB’s bias is towards further rate hikes. We expect two more 25bp hikes in each June and July. We expect a rate cut cycle to begin in December as the economy is likely to prove much weaker than the ECB currently expects in the second half of the year. Moreover, headline inflation should drop sharply in the coming months and underlying inflationary pressures and core inflation should ease in the course of the year.
Fed – The FOMC raised the fed funds rate, probably for the final time this cycle, by 25bp in May. We expect the Fed will keep a tightening bias for now, but 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 cut 25bp at each of the eight meetings in 2024, taking rates back to near neutral levels by end-2024. The risks to this forecast are skewed towards 1-2 more hikes if the economy proves to be more resilient, and/or potentially a later start to rate cuts.
Bank of England – The shock core inflation reading for April means the BoE is likely to hike once more in June, taking Bank Rate to 4.75%. MPC decisions over the next few months will be highly sensitive to incoming data, and we do not rule out further rate hikes. We have also pushed out the expected start to rate cuts to Q2 24, from Q4 23 previously, as we expect inflationary pressure to prove more sticky. This led us to significantly raise our end-2024 Bank Rate forecast, to 3.75% from 3.00% previously.
Bond yields – Given our macro and central bank outlook, we judge that the rate hike cycle is approaching its end. We expect both central banks to start cutting rates by end 2023. As such, we forecast lower US and Euro rates going forward, with both the Treasury and Bund curve inversion peak now likely 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 has already started as the market has already started to price in rate cuts in 2023 and 2024.
FX – We recently downgraded our EUR/USD forecast for 2024 from 1.16 to 1.10. First, we expect aggressive rate cuts for the Fed and the ECB. Even though we expect more cuts for the Fed, we are further away from market consensus for the ECB. Second, the options market is not convinced about a higher EUR/USD. Third, speculators already hold a substantial amount of long euro positions. Dynamics on the US debt ceiling could weigh on the dollar in the near term, but the pricing out of Fed rate cuts in the coming months should support the dollar. Market panic would be positive for the dollar.
This article is part of the Global Monthly of May 23