• Economy

Economic Outlook 2023: mid-April update

Hélène Baudchon
Hélène Baudchon
Senior Economist, Head of OECD experts of the Economic research team

With the benefit of hindsight, we can see clear trends in 2022, particularly the surge in inflation and the rapid series of large rate hikes that central banks carried out to combat it. A year ago, however, the extent of those two shocks was not at all a foregone conclusion: in April 2022, the outlook for inflation, growth and monetary policy was not nearly as clear as it might appear today in retrospect.Hélène Baudchon, Senior Economist, Head of OECD experts of the Economic research team explains further.

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?

(Much?) lower inflation

Our first “certainty” is that inflation will fall. However, recent indicators have shown that the process will not be steady  and have confirmed that it will also be fairly slow. As expected, energy prices are contributing less to annual inflation , but food inflation remains very high, particularly in the Eurozone , with limited prospects that it will fall rapidly. 

In addition, core inflation (excluding energy and food) remains stubbornly high: it has not yet started to ease in the Eurozone (5.7% year-on-year in March), while the decline remains hesitant in the US (5.6%). We continue to expect core inflation to fall more in the next few months as supply-side inflationary pressures subside, but on the demand side pressures are likely to persist and take longer to fade.

 [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.
A blurred croud of undidentifyable people in the street

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%.

(Much?) lower growth

Although inflation’s resistance to fall is not really a surprise, the resilience of growth is. The Eurozone recession that looked inevitable in late 2022-early 2023, because of factors such as high inflation and the energy crisis, has not materialised. Although gas and electricity prices surged, the shock was partly absorbed by government support, and much-feared energy shortages were avoided because of the mild winter, energy-saving measures and efforts to find new sources of supply.

 Business sentiment, overly pessimistic in late 2022, has risen in the first months of 2023 due to a wave of relief, also helped by the fall in energy prices. Besides, some sectors are still bringing production back up to pre-Covid levels and are seeing fewer delays caused by supply-chain issues, which is giving a larger-than-expected support to output. China’s sudden scrapping of its zero-Covid strategy and decision to reopen has also provided a boost.

The Eurozone remains on the edge

The resilience of Eurozone growth is very good news, but a recession can still not be ruled out in the next few quarters given that monetary tightening will continue to have an impact. Granted, a recession is no longer our central scenario in April, but the Eurozone remains on the edge: we expect growth to be modestly positive in the first half of 2023, but after that, we have downgraded our growth forecasts in the wake of the SVB episode and now expect GDP to stagnate between mid-2023 and early 2024. 

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 

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