Key views on Global Monthly - Winter is coming
The energy crisis in Europe is intensifying, and we now expect deep recessions in the eurozone and UK economies. Consumption growth is being weighed by the biggest fall in real incomes in decades, while industry is being hampered by sky-high energy prices and worries over potential shortages as we move into the winter months. Elevated energy prices and supply disruptions are delaying the normalisation in inflation, raising the risk that it becomes more entrenched. Upside inflation risks mean the Fed is likely to continue raising rates rapidly at coming meetings. The ECB is expected to continue tightening policy, 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 – The economy is expected to move into recession in the coming quarters. We have pencilled in a modest contraction in GDP in Q3 and two more significant contractions in 2022Q4 and 2023Q1. Our annual average growth forecast drops to 2.7% in 2022 (down from 2.9% previously) and to around -1% in 2023 (down from +1.3% previously). Domestic demand will be hit by ongoing very high (energy) inflation and tightening financial conditions, which will also reduce job growth and fixed investment. Exports will suffer from slower world trade growth.
Netherlands – Second quarter growth in 2022 surprised to the upside with 2.6% qoq. This was particularly driven by investment, which had been lagging behind due to supply bottlenecks and labour shortages, and catch-up growth in (services) consumption. Considering the many headwinds from (energy) inflation, gas shortages and monetary tightening, the Netherlands cannot escape a small contraction at years end. But, we expect the contraction to be less severe than for the broader eurozone, partially due to the historically tight labour market.
UK – Inflation rose to 10.1% in July, and is set rise further in October following revised household energy cap from Ofgem, which will lead to energy bills rising by 80%. The economy contracted slightly in Q2, and we expect this contraction to continue over the coming quarters, with the unemployment rate likely to start rising from late this year onwards. The labour market remains strong for the time being, with inflation driving bigger pay settlements, suggesting the economy may be in the early stages of a wage-price spiral.
US – Despite the contraction in GDP in Q2, demand indicators overall have been solid – particularly private consumption and jobs 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, with the NBER likely to declare a recession next year. Risks to inflation continue to be to the upside, potentially requiring even bigger interest rate rises to bring back down.
China – Last month, we cut our 2022 annual growth forecast to 3.7%, almost 2 %-points below Beijing’s target. Largely reflecting payback from the Q2 lockdown slump, we still expect above-trend sequential growth in 2H-2022. This also assumes the nationwide lockdown intensity to remain lower than in March/April and Beijing to continue with additional support, including for the property sector. China’s post-lockdown rebound will be less spectacular than in 2020, given headwinds from strict Covid-19 policy, real estate woes, power shortages and weak global growth.
Central Banks & Markets
ECB – Following the 50bp rate hike at the July meeting, and the introduction of the new Transmission Protection Instrument (TPI), we expect another 50bp rate hike in September. Next, two more hikes of 25bp each are expected in October and December, when the discount rate should reach 1.00%. We have not pencilled in any rate hikes after that as the economy is expected to move into recession. The risks to our forecast for ECB policy are skewed to more rate hikes in the 3-6 month horizon, given that the ECB's focus is on inflation rather than growth.
Fed – Given persistently elevated inflation in the US, and upside risks to the outlook, we expect the Fed to hike rates a further 50bp in September, with risks tilted to another 75bp move. We continue to expect the upper bound of the fed funds rate to reach 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 led the MPC to hike rates by 50bp at the August meeting. We expect now expect further 50bp hikes in September and November, with Bank Rate to peak at 3.0% by year end. We think that by next 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 second half of next year, this could raise the prospect of the MPC reversing course and cutting rates, perhaps in late 2023.Bond yields – Given our macro revisions, we expect both Treasury and German bonds to rally from Q4 until mid-2023. We expect the 10y US Treasury yield to slide to 2.55% in Q4 2022. Similarly, we expect 10y Bund yield to fall to 1.1% by Q4 due to US spill-over effects and markets shifting back to risk-off mode, increasing safe-haven demand. However, as short-term inflation expectations continue to rise, we expect a stronger inversion of the Treasury curve and the Bund curve to bear-flatten in the near-term before steepening again in H2 2023.
FX – On 17 August we made a modest adjustment in our forecasts. A recession in the eurozone combined with a more aggressive path of rate hikes in the US compared to the eurozone will probably keep the euro under pressure versus the US dollar this year. But we still think that a sustained move in EUR/USD below parity will be difficult. Therefore, we keep our forecasts for EUR/USD for end 2022 at 1.0. In 2023 we expect narrowing yield spreads between the US and Germany to support the euro, with our end-2023 forecast at 1.10 (was 1.15).