The European Central Bank is expected to continue hiking interest rates aggressively in the near term as the eurozone economy is proving more resilient than expected.
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After China’s reopening and a spate of upbeat data surprises in recent weeks, economists are upgrading their previously gloomy outlook for the global economy.
Data releases over the past week have shown signs of inflation slowing and less severe activity declines leading to this 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 due to the 1.0pp increase in our growth forecast for China to 4.8% compared to last week, but also reflects a 0.7pp increase for the Eurozone (to -0.1%, mainly due to a much better Germany) forecasts, and to a lesser extent 0.2pp upgrades for the US (to 0.6%), Japan (to 1.0%) and UK (-0.7%)”, said Christian Keller, head of economic research at Barclays.
“The US would still experience a recession as we forecast slightly negative growth in three quarters (Q2 – Q4 2023), but it would be quite superficial as annual GDP growth would now remain positive in 2023.”
The US CPI for December edged down 0.1% mom to 6.5% yoy, in line with expectations, mainly driven by falling energy prices and slower food price increases.
However, Keller suggested that the December Atlanta Fed Wage Tracker was a more important gauge of how the US economy is doing and how the Federal Reserve’s monetary tightening might play out.
Last week’s estimate supported the previous week’s Average Hourly Earnings (AHE) data by pointing to a significant slowdown in wage pressures, falling a full percentage point year-on-year to 5.5%.
Philadelphia Fed President Patrick Harker, a new voting member of the Federal Open Market Committee, said last week that raising rates by 25 basis points was appropriate to move forward. A similar tone was struck by Boston Fed President Susan Collins and San Francisco Fed President Mary Daly.
The central bank has aggressively hiked interest rates to curb inflation in hopes of a soft landing for the US economy. Barclays believes the balance in the FOMC has shifted towards 25 basis point moves since the February meeting, in line with market prices.
Where the British bank differs from market prices is in its expectations for the terminal rate. Barclays forecasts that the FOMC will hike the Fed’s interest rate to 5.25% at its May meeting before the rate-hike cycle ends, taking current market prices to a peak of just under 5% while policymakers wait for more Evidence of slowing labor demand and wage pressures await.
Barclays hinted that stalled core inflation in the euro area will keep the European Central Bank on track to complete its two cabled 50 basis point hikes in February and March before ending its tightening cycle at a 3% deposit rate while continuing to tighten its balance Sheet.
Inflation has proved more stubborn in the UK, where the labor market also remains tight, energy bills are expected to rise in April and widespread industrial action is putting upward pressure on wage growth, prompting economists to warn of possible second-round inflationary effects.
Barclays’ updated outlook sees the Bank of England raising another 25 basis points in May after 50 basis points in February and 25 basis points in March, taking the final interest rate to 4.5%.
Less recession in Europe and UK
Surprisingly strong activity data in the Eurozone and UK last week could give central banks further leeway to raise rates and bring inflation back to earth.
“This week’s better-than-expected GDP data for Germany and the UK – the epicentres of growth pessimism – provide further evidence that the economic fallout has been less severe than the much more uncertain energy situation hinted at a few months ago,” Keller said.
“Although it varies from country to country, the generally large fiscal support packages in Europe and the UK to cope with higher energy prices must also have helped, as well as healthy labor market conditions and, on average, robust household savings.”
Berenberg has also raised its forecast for the euro zone given the latest news, notably falling gas prices, a recovery in consumer confidence and a slight improvement in business expectations.
On Friday, the Federal Statistics Office showed that Europe’s biggest economy stagnated rather than contracted in the fourth quarter of 2022, and Berenberg chief economist Holger Schmieding said its apparent resilience has two important implications for the prospects of the 20-member common currency bloc.
“As Germany is more exposed to gas risks than the eurozone as a whole, this suggests that the eurozone probably did not underperform (much) than Germany late last year and thus may have avoided a significant fall in GDP in the fourth quarter,” said 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 the first quarter of 2023, Berenberg now forecasts a decline of just 0.3% over the period.
“With less ground to be gained, the pace of the recovery will also be somewhat less steep in the second half of 2023 and early 2024 after a likely stabilization in the second quarter of 2023 (0.3% qoq in the fourth quarter of 2023, 0.4% quarter-on-quarter in Q1 and 0.5% qoq in Q2 2024 instead of 0.4%, 0.5% and 0.6% qoq, respectively),” added Schmieding.
Berenberg therefore increased its calls for an annual average change in real GDP in 2023 from 0.2% contraction to 0.3% growth.
The German investment bank also raised its forecast for the UK for 2023 to a fall of 0.8% from a 1% decline for the year, citing Brexit, the legacy of former Prime Minister Liz Truss’ disastrous economic policies and tighter fiscal policy for the UK’s continued underperformance versus the eurozone.
Positive economic surprises – notably the 1% monthly rise in euro area industrial production in November – combined with unusually mild temperatures that have lowered energy demand and a quick reopening in China also prompted TS Lombard on Friday to raise its euro area growth forecast – 0.6% to -0.1% for 2023.
While consensus forecasts are moving towards absolute positive growth as worst-case scenarios for the eurozone are priced out, Davide Oneglia, senior economist at TS Lombard, said an “L-shaped recovery” is still the most likely scenario for 2023 be and no full recovery .
“This is the result of three main factors: 1) the cumulative ECB tightening (and the impact of global monetary tightening) will take full effect on the real economy in the coming quarters; 2) the US economy is poised to decelerate further; and 3) China is reopening to a sluggish economy where pro-growth policy drivers will end up mainly favoring a revival of domestic consumer services, with limited benefits for EA capital goods exports,” Oneglia said.
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