Key views on Global Monthly February 2023

Macro

Eurozone – 2022Q4 GDP came in stronger than expected, at +0.1% qoq. Still, there is weakness under the surface and growth was supported by a number of temporary factors. The impact of past and upcoming interest rate hikes on the economy will increasingly be felt. We expect GDP to contract moderately during most of 2023. A drop in energy price inflation has lowered headline inflation since October. Core inflation is more resilient and will decline more slowly than the headline rate this year. There still is no evidence of a longer lasting sharp acceleration in wage growth.

Netherlands – GDP growth of +0.6% qoq surprised to the upside and reflects an easing energy crisis, government support and strong employment growth. We expect further cooling of headline inflation but ongoing broadening of price pressures to core. We raised our annual average inflation forecasts (HICP) to 4.6% in 2023 and 4.1% in 2024. The labour market is expected to soften a touch, but overall tightness is here to stay. Given still elevated inflation, softening external demand and increasing monetary headwinds, we expect annual growth to slow to 1.2% in 2023 (from 4.5% in 2022).

UK – While the easing energy crisis will soften the blow to household real incomes, the tax burden is set to rise significantly over the coming year. We expect a shallow recession in the first half of this year and a tepid recovery thereafter. The medium term outlook will critically depend on the evolution on labour productivity which remains weak. CPI inflation has eased, but wage inflation remains elevated. The risk to inflation is skewed to the upside because of a structural shortage of workers and public sector unrest.

US – The US consumer exhibited surprising resilience for much of 2022, but the twin headwinds of falling real incomes and dwindling excess savings are now exerting a bigger drag on consumption. Investment is also expected to remain weak in the near term. This will help inflation along its downward-sloping trend, while labour hoarding is likely to give way to a rise in the unemployment rate. This will lead to the NBER likely declaring a recession. Inflation is expected to fall significantly this year on the back of sharply easing pipeline pressures, and be within touching distance of 2% by the end of the year.

China – After three years of heavy restrictions, the Chinese were finally able again to travel to their families around Lunar New Year (LNY). With no signs of over-whelming public health concerns and related disturbances following the LNY holiday, we think the way is paved for a staged recovery in domestic demand, with GDP growth strengthening from Q1-2023 onwards. January data published so far point to a meaningful improvement in activity and sentiment. Bank lending to corporates did clearly pick up, although household lending is still subdued.

Central Banks & Markets

ECB – The ECB has raised the deposit rate by 50bp in February and has pre-signalled another 50bp hike in March. We have maintained our forecast that the deposit rate will peak at 3%, implying that the March hike would be the final one. We expect the ECB to pause after March, as the economy is contracting moderately, inflation falls and unemployment rises. We see a first rate cut in 2023Q4. The risks to our view are skewed toward a more aggressive path on the 3-month horizon. The ECB also is gradually ending reinvestments under its APP bond portfolio, but will continue them under the PEPP.

Fed – The FOMC raised the fed funds rate by 25bp in February, as was widely expected. We expect another 25bp hike in March. Subsequently, we expect the Fed to pause, assuming inflation continues to move lower and the labour market deteriorates. We think further rate hikes will ultimately prove unnecessary, and that by September, the Fed will be ready to start pulling back from the current highly restrictive policy stance. Our base case is for a total of 125bp in rate cuts in late 2023, which would leave the fed funds rate at a still-restrictive level of 3.50-3.75% by year end. The risk to near-term rates is still to the upside.

Bank of England – The continued risk of a wage-price spiral in the UK led the MPC to hike Bank Rate by a further 50bp at the February meeting to 4%. The policy rate is close to neutral levels and as a result, MPC decisions over the next few months are highly sensitive to 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. We believe that the MPC will raise Bank Rate by 25bp in March and pause at this level before reversing course towards the end of this with the year-end policy rate at 4.0%.

Bond yields – Given our economic and central banks outlook, we think both the 10y US and Bund yields currently are at peak levels. The recession will weigh on EZ rates this year, with the 10y Bund yield expected to fall below 2%. A similar path (albeit at a higher level) is expected for US rates. Both Treasury and Bund curves are expected to remain inverted until around the middle of 2023, as elevated core inflation will keep short-term rates higher for longer. Thereafter, we expect both curves to bull-steepen in the second half of the year on the back of monetary easing, with 125bp and 50bp in rate cuts pencilled in for the Fed and ECB rates respectively.

FX – Earlier in the month EUR/USD cleared the psychological level of 1.10. Since then there has been some profit taking on the back of Fed commentary, with EUR/USD moving back towards 1.07. As long as EUR/USD is above 1.0325 the long-term trend is positive. We think there is more upside in EUR/USD for 2023 and 2024. This is mainly driven by a narrowing of the difference in policy rates and government bond yields between the US and the eurozone as a result of more the more aggressive rate cuts we expect for the Fed compared to the ECB at the end of 2023. Our forecast for the end of 2023 for EUR/USD is 1.12 and to 1.16 end of 2024.