In April 2023, looking ahead, what trends can we see and how certain about them are we?
As regards the United States and the Eurozone, three trends seem relatively obvious. They have not changed since December, when we first sketched out this year’s likely developments. The questions we asked back then remain entirely relevant[1] and we have the same level of certainty about the broad trends – i.e. we are very likely to see lower inflation, slower growth and the end of monetary tightening – and the same level of uncertainty about the exact timing and extent of those developments. However, some elements of the background have somewhat changed in the last five months. The present update aims to show what has changed and what has not.
[1] Will inflation fall, or rather how much will it fall? When will the Fed and ECB stop raising official interest rates, and how high will they be at that point? Will growth remain resilient or succumb to the build-up of shocks?
[2] There was almost no fall in inflation in the US in January and in the Eurozone in February, although there were more significant declines in March: year-on-year inflation was 6.9% in the Eurozone (down 3.7 points from its October 2022 peak) and 5% in the US (down 4.1 points from its June 2022 peak).
[3] In March 2023, the contribution of energy prices to inflation was near-zero in the Eurozone (versus a peak of 4.4 points a year ago), and slightly negative in the US (versus a peak of 4 points in June 2022). According to our forecasts, it should be slightly negative over the year as a whole.
[4] Contribution to annual inflation slightly above 3 points in the Eurozone, as opposed to 1 point in the US.
End of monetary tightening
The second “certainty” is that monetary tightening will come to an end, i.e. we expect policy rates to peak in 2023. However, the last few months have shown that although the direction of travel is relatively clear – the Fed and ECB have probably not quite finished raising rates but are closer to the end of the cycle than to the start – the endpoint is still very much up in the air. Market expectations of when the cycle will end are varying according to inflation figures, with recession fears having taken a back seat given that economic activity figures have been fairly good overall in early 2023. At the time of writing, however, the end of the monetary tightening cycle has moved much closer following the difficulties experienced by certain regional US banks in March (which we refer to below as the “SVB episode”): these problems are likely to cause an additional tightening of financial conditions and lending standards, partly substituting central-bank rate hikes [5].
[5] According to our current forecasts, the Fed funds rate will be hiked by a final 25bp in May, taking it to 5.25% (upper band). We expect the ECB to hike rates twice, in May and June, taking the deposit rate to 3.50% and the refi rate to 4%.
The Eurozone remains on the edge
In the US, the expected recession is also proving slow to arrive. Nevertheless, a recession remains our base case. We now expect it to happen one quarter later than before, and to be slightly deeper following the SVB episode. It should remain shallow, however – running from the third quarter of 2023 to the first quarter of 2024, with a cumulative 1% drop in GDP. On both sides of the Atlantic, the shock of elevated inflation and monetary tightening is being cushioned by the aforementioned catch-up effects, the ongoing impact of fiscal support measures, hiring difficulties – prompting companies to hoard staff – and the urgent need to invest heavily in energy transition.
Multiple sources of uncertainty
The aforementioned “certainties” are accompanied by numerous uncertainties and downside risks, including, for some months now, the evolution of the war in Ukraine and that of inflation and interest rates . More recently, in the United States, the SVB episode was a reminder of the challenge posed by the sharp monetary tightening and its consequences.
Central banks continue to emphasize their data-dependency in their communications. The Fed’s and the ECB’s attention to core inflation, which is slow to fall, has been complemented, especially in the US, by close monitoring of credit developments. Beyond the changing financing conditions of the economy, to be closely monitored, the situation of the commercial and, to a lesser extent, residential real estate market also needs surveillance.
[6] In the Eurozone, gas prices are also a risk, since they could surge again as stocks are replenished ahead of the 2023/24 winter.
For more economic information and analysis: The BNP Paribas Economic Research portal (unavailable link)