The European Central Bank is expected to continue raising rates aggressively in the short-term as the euro zone economy proves more resilient than anticipated.
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After China’s reopening and a deluge of positive data surprises in recent weeks, economists are upgrading their previously gloomy outlooks for the global economy.
Data releases last week showed signs of inflation slowing and less severe downturns in activity, prompting Barclays on Friday to raise its global growth forecast to 2.2% in 2023, up 0.5 percentage points from its last estimate in mid-November.
“This is largely driven by the 1.0pp increase in our China growth prediction to 4.8% from last week, but also reflects a 0.7pp increase for the euro area (to -0.1%, largely on a much better Germany) forecasts, and, to lesser extent, upgrades of 0.2pp for the US (to 0.6%), Japan (to 1.0%) and the UK (-0.7%),” said Barclays Head of Economic Research Christian Keller.
“The U.S. would still experience a recession, as we predict slightly negative growth in three quarters (Q2 -Q4 2023), but it would be quite shallow, as annual 2023 GDP growth would now remain positive.”
U.S. December CPI edged down 0.1% month-on-month to notch 6.5% annually, in line with expectations and mostly driven by falling energy prices and slowing food price increases.
However, Keller suggested a more important gauge of how the U.S. economy is faring, and how the Federal Reserve’s monetary policy tightening might unfold, was the December Atlanta Fed Wage tracker.
The estimate last week supported the previous week’s average hourly earnings (AHE) data in indicating a sharp deceleration of wage pressures, declining by a full percentage point to 5.5% year-on-year.
Philadelphia Fed President Patrick Harker, a new voting member of the Federal Open Market Committee, said last week that 25 basis point interest rate hikes would be appropriate moving forward. A similar tone was struck by Boston Fed President Susan Collins and San Francisco Fed President Mary Daly.
The central bank has been raising rates aggressively to rein in inflation while hoping to engineer a soft landing for the U.S. economy. In line with market pricing, Barclays believes the balance on the FOMC has now shifted toward 25 basis point increments from February’s meeting onward.
Where the British bank differs from market pricing is in its expectations for the terminal rate. Barclays projects the FOMC will lift the Fed funds rate to 5.25% at its May meeting before ending the hiking cycle, exceeding current market pricing for a peak of just below 5%, as policymakers wait to see more evidence of slowing labor demand and wage pressures.
Barclays suggested that sticky core inflation in the euro area will keep the European Central Bank on track to deliver its two telegraphed 50 basis point hikes in February and March before ending its tightening cycle at a deposit rate of 3%, while continuing to tighten its balance sheet.
Inflation has proven more persistent in the U.K., where the labor market also remains tight, energy bills are set to increase in April and widespread industrial action is exerting upward pressure on wage growth, prompting economists to warn of potential second round inflationary effects.
Barclays’ updated outlook pencils in a further 25 basis point hike from the Bank of England in May after 50 basis points in February and 25 in March, taking the terminal rate to 4.5%.
Shallower recessions in Europe and the UK
Surprisingly strong activity data in the euro zone and the U.K. last week may offer further headroom for central banks to raise rates and bring inflation back to Earth.
“This week’s better-than-expected GDP data for Germany and the U.K. — the epicenters of growth pessimism — add further evidence that the economic fallout has been less severe than the much more uncertain energy situation suggested a few months ago,” Keller said.
“Although varying by country, the generally large fiscal support packages in Europe and the UK to deal with elevated energy prices must also have contributed, as have healthy labour market conditions and, on average, robust household savings.”
Berenberg also upgraded its euro zone forecast in light of recent news flow, particularly falling gas prices, a consumer confidence recovery and a modest improvement in business expectations.
On Friday, the German federal statistics office showed that Europe’s largest economy stagnated in the fourth quarter of 2022 rather than contracting, and Berenberg Chief Economist Holger Schmieding said its apparent resilience has two major implications for the outlook across the 20-member common currency bloc.
“As Germany is more exposed to gas risks than the euro zone as a whole, it suggests that the euro zone likely did not fare (much) worse than Germany late last year and may thus have avoided a significant contraction in Q4 GDP,” Schmieding said.
“Judging by the ongoing recovery in business and consumer confidence, it seems unlikely that Q1 2023 will be much worse than Q4 2022.”
Instead of a cumulative real GDP decline of 0.9% in the fourth quarter of 2022 and first quarter of 2023, Berenberg now forecasts only a 0.3% decline over the period.
“With less lost ground to make up for, the pace of the rebound in 2H 2023 and early 2024 after a likely stabilisation in Q2 2023 will also be a bit less steep (0.3% qoq in Q4 2023, 0.4% qoq in Q1 and 0.5% qoq in Q2 2024 instead of 0.4%, 0.5% and 0.6% qoq, respectively),” Schmieding added.
Berenberg therefore raised its calls for the annual average change to real GDP in 2023 from a 0.2% shrinkage to 0.3% growth.
The German investment bank also upped its 2023 U.K. forecast from a 1% contraction for the year to a 0.8% contraction, citing Brexit, the legacy of former prime minister Liz Truss’ disastrous economic policy and a tighter fiscal policy for the U.K.’s continued underperformance versus the euro zone.
Positive economic surprises — particularly the 1% monthly increase in euro area industrial production in November — along with unseasonably mild temperatures, which have eased energy demand, and a fast reopening in China also led TS Lombard on Friday to lift its euro area growth forecast from -0.6% to -0.1% for 2023.
While consensus forecasts are moving toward outright positive growth as worst-case scenarios for the euro zone are priced out, TS Lombard Senior Economist Davide Oneglia said an “L-shaped recovery” is still the most likely scenario for 2023, rather than a full rebound.
“This is the result of three major factors: 1) cumulated ECB tightening (and the spillovers from global monetary tightening) will start to show its full effect on the real economy in the coming quarters; 2) the US economy is poised to lose altitude further; and 3) China is reopening into a weak economy, in which pro-growth policy drivers will end up mostly favouring a revival in the domestic consumer services with limited benefits for EA capital goods exports,” Oneglia said.
