Based in Paris, BNP Paribas' Economic Research Department is composed of economists and statisticians:
« The Economic Research department’s mission is to cater to the economic research needs of the clients, business lines and functions of BNP Paribas. Our team of economists and statisticians covers a large number of advanced, developing and emerging countries, the real economy, financial markets and banking. As we foster the sharing of our research output with anyone who is interested in the economic situation or who needs insight into specific economic issues, this website presents our analysis, videos and podcasts. »
+ 33 1 55 77 47 31 william.devijlder@bnpparibas.com
US economic policy uncertainty based on media coverage has increased slightly recently, reflecting the hawkish tone of the Federal Reserve and hence concern about the extent and the impact of additional monetary tightening. In the US, business uncertainty about sales revenue growth has declined slightly as of late after a rising trend lasting several months.
The last twelve months, inflation has continued to surprise to the upside, due to a combination of a series of supply shocks (covid-19, disruption and shortages, the war in Ukraine, weather conditions) and the strength of demand, which had been underestimated. Today, the broad-based nature of inflation and its persistence are the real issues, which reduce the visibility in terms of future inflation developments. Therefore, central banks have decided to change their approach. The theory of inflation and monetary policy has been put aside, the only thing that matters are the data. The main worry of the ECB and the Fed is that inflation expectations become unanchored and influence pricing decision of companies as well as wage negotiations
At the Jackson Hole symposium, Fed chair Powell and Banque de France governor Villeroy de Galhau have insisted that their responsibility to deliver price stability is unconditional. It gives a new meaning to ‘whatever it takes’. Faced with uncertainty about the persistence of elevated inflation, the Federal Reserve and the ECB will increase their policy rates to bring inflation under control, whatever the short-run cost to the economy, because not doing enough now would entail an even bigger economic cost subsequently. Equity markets declined and bond yields moved higher. Tighter financial conditions will help the monetary tightening in achieving the desired slowdown in growth
The ECB Governing Council has surprised markets by a 50 bp rate hike and by dropping its forward guidance and moving to a data-dependent tightening cycle. This may reflect unease about how quickly the euro area economy might react to the policy moves and about the consequences of uncertainty about gas supply during the winter months. Another key decision was the introduction of the Transmission Protection Instrument (TPI), a tool to address unwarranted spread widening that would weigh on the effectiveness of monetary policy transmission. The data dependency of further rate hikes and the vagueness about the triggers for using the TPI may lead to an increase of the volatility in interest rates and sovereign spreads whereby investors try to understand the ECB’s reaction function.
Next Thursday’s meeting of the ECB Governing Council is eagerly awaited. The rate hike decision has been pre-announced so the more important question is whether the new tool to address unwarranted sovereign spread widening will be unveiled. The rationale for such an instrument is well understood but its design and use raise several questions. One is easy to answer. To avoid a conflict with the monetary policy stance, bond purchases by the central bank would need to sterilized. The others are more challenging. Where is the threshold to call a spread widening ‘unwarranted’? Should the ECB be clear or ambiguous on this threshold and on its reaction when it would be reached? The final question concerns moral hazard and, hence, conditionality
The prospect of several rate hikes by the Federal Reserve, as well as the risk of disruption of gas supply in Europe and its negative impact on growth, are the main factors that have recently caused a depreciation of the euro versus the dollar, leading to a parity between the two currencies. The economic consequences are significant for the euro area and predominantly negative, the only positive one being a gain in competitiveness. In the short term, a change in direction is unlikely but in the medium term the euro should strengthen against the dollar.
Recent data send conflicting signals about the outlook for the US economy. A survey of chief financial officers shows they have become gloomier and the nowcast of the Federal Reserve Bank of Atlanta is forecasting a contraction of real GDP in the second quarter. This would mean two successive quarters of negative GDP growth, which corresponds to the popular definition of a recession. However, the labour market continues to be strong and the majority of indicators used by the NBER Business Cycle Dating Committee are still in an uptrend. This suggests there is no imminent risk of recession yet.
The downward trend of the global manufacturing PMI continued in June. The index dropped in the US and declined in the euro area to respectively 52.7 and 52.1, which brings us close to the crucial 50 mark. The various euro area countries for which data are available all recorded lower numbers. Data were also weaker in the UK and Japan. Australia, Mexico and, in particular, China saw an improvement.
The chief financial officers of US companies have become gloomier about the outlook for the US economy. The latest Duke University CFO survey shows that 20.8% of the participants expect negative GDP growth over the next 12 months. The assessment about the own-company prospects has declined far less, leading to a record high gap with the outlook for the economy as a whole. This is a source of concern: how long can own-company confidence remain high if the overall environment continues to deteriorate? Interest rate developments will play a key role in this respect. Of those US companies that plan to borrow, two-thirds would reduce their investments in case of an increase of borrowing costs of 3 percent. It is a sobering message considering the expected tightening of monetary policy.
Our different uncertainty gauges are complementary, in terms of scope and methodology. Starting top left and continuing clockwise, US economic policy uncertainty based on media coverage has eased slightly in recent weeks after a significant increase, triggered, at least in part, by concern about the prospect of aggressive rate hikes by the Federal Reserve. In the US, business uncertainty about sales revenue growth has increased slightly as of late but it has decreased significantly with respect to employment growth. The European Commission’s uncertainty index has edged higher.
The level of activity in the US and the euro area is very high but growth has already slowed down significantly and quarter over quarter growth should remain low for the remainder of the year. Worries about the cyclical outlook are on the rise due to a combination of elevated inflation, geopolitical uncertainty and monetary policy tightening. Survey data on input prices and delivery times have eased but the levels are still very high. Wage growth remains strong in the US and is picking up in the euro area, creating concern that inflation would decline more slowly than expected. In addition, assessing the true state of demand has become very difficult.
A lasting, unwarranted widening of sovereign spreads in the euro area would represent an excessive tightening of financial conditions and weigh on activity and demand. It would run into conflict with the objectives of the ECB in the context of its monetary policy normalisation. Spreads are influenced by various fundamental variables that are directly or indirectly related to debt sustainability issues. These tend to be slow-moving. Sovereign spreads also depend on the level of risk aversion, a variable that fluctuates a lot and which is influenced by global factors. This complicates the assessment of whether an observed spread widening is warranted or not.
In recent weeks, the prospect of several ECB rate hikes has caused an increase in Bund yields and, unexpectedly, several sovereign spreads. Beyond a certain point, higher spreads may become unwarranted. Under such circumstances, the ECB might consider stepping in to avoid that its policy transmission would be impacted. Determining whether sovereign spreads have increased too much is a real challenge. Historically, based on a 20-week moving window, the relationship (beta) between the BTP-Bund spread and Bund yields fluctuates a lot, so this calls for taking a longer perspective. Using data since 2013, the current spread is in line with an estimate based on current Bund yields. Clearly, other economic variables should be added to the analysis
The global economy has been hit by multiple shocks this year: new Covid-19 cases in China, the war in Ukraine, rising interest rates. Financial market behaviour and the US Survey of Professional Forecasters point to mounting concerns about the risk of a recession. These worries come with a cost to the economy and may cause growth to slow down further. Some degree of concern is welcome because it enhances the effectiveness of a restrictive monetary policy. There is a tipping point however, beyond which slowdown fears become self-fulfilling. Addressing these would be difficult if by then inflation has not yet converged sufficiently to target.
In this series of podcasts, William De Vijlder, Group Chief Economist of BNP Paribas, discusses the issue of stagflation, a term that has been increasingly used in the media in recent months. Stagflation, a multi-year phenomenon combining rising unemployment and high inflation, brings us back to the dark days of the 1970s and 1980s, when inflation levels were unprecedented and mass unemployment began. In the current economic environment, which bears the brunt of the shocks of the COVID-19 pandemic and the war in Ukraine, inflation is exceptionally high. Should we fear the return of stagflation? What is the central banks' room for manoeuvre to address the issue of a high and persistent inflation without damaging growth? And what can fiscal policy do to cushion economic shocks?
Since the start of the year, media increasingly use the word recession and, over the same period, there was a significant increase in Treasury yields. The common driver behind these developments is, to a large degree probably, the more hawkish tone from the Federal Reserve. Unease about recession risk shows up in the latest quarterly Survey of Professional Forecasters conducted by the Federal Reserve Bank of Philadelphia. Recession probabilities across the projection horizon have moved higher and they are now well above what we have seen in the past at this stage of the tightening cycle. Exceptionally high inflation requires aggressive rate hikes to bring it back under control
The global manufacturing PMI continues its sideways movement since March, when it had declined due to the war in Ukraine. May saw a weakening in the US and the euro area, where in particular Italy recorded a considerable decline. In Australia the PMI recorded a big drop. China saw a rebound following the easing of mobility restrictions. In India the PMI has been stable at a high level for several months and Vietnam saw a sizeable improvement in May. The services PMI was down in the US and the euro area, where in particular Germany was confronted with weaker data, although still well above the 50 mark. In the UK, the index recorded a huge drop. Japan is benefiting from better data and in India the already elevated index moved higher again in May.
Climate change and the energy transition are high on the European agenda. Last year, 'Fit for 55' was presented, a plan to deliver the EU's 2030 climate target on the way to climate neutrality and to reduce greenhouse gas emissions by at least 55% by 2030. Following the war in Ukraine, REPowerEU was launched, with the ambition to rapidly reduce dependence on Russian fossil fuels and fast forward the green transition. These initiatives imply that millions of households and businesses will need to make investments in order to save energy and use alternative energy sources.
Historically, there is a close relationship in the US and the euro area between, on the one hand, a measure of price pressures based on survey data on manufacturing delivery times and input prices, and, on the other hand, core inflation. The recent flash purchasing managers’ indices show that price pressures may be peaking, thereby providing hope that inflation will follow in the not-too-distant future. This will focus the attention to the speed of decline in inflation. A very slow process would be highly discomforting, raising fears that ever-higher interest rates would end up causing a recession. Everybody wants slower growth to bring inflation under control, but nobody wants the growth engine to stall.
Our different uncertainty gauges are complementary, in terms of scope and methodology. US economic policy uncertainty based on media coverage has eased slightly after a significant increase, reflecting concern about the impact of aggressive monetary policy tightening. In the US, business uncertainty about sales revenue growth has been stable but uncertainty about employment growth has rebounded somewhat, probably reflecting ongoing difficulties in filling vacancies. The European Commission’s uncertainty index, after having jumped following the war in Ukraine, has stabilised.
Uncertainty matters greatly for households and businesses when taking decisions. It can have many causes: economic, economic policy, political or even geopolitical. Survey data of the European Commission show that the Covid-19 pandemic has caused a huge jump in uncertainty, followed by a gradual decline. The war in Ukraine has triggered another, albeit more limited, increase. It will be important to monitor the development of uncertainty in the coming months at the level of consumers, businesses and individual countries. In the absence of a decline, one should expect that the negative impact shows up in spending and activity data.
At first glance, higher inflation seems like good news for governments. After all, inflation erodes the real value of debt and lowers the public debt/GDP ratio through a higher nominal GDP. However, the impact of inflation on public finances depends on whether higher inflation was anticipated by financial markets and on its expected persistence. Both factors would influence the borrowing cost and hence the dynamics of the debt ratio through the difference between this cost and nominal GDP growth. Public finances should benefit from having a central bank that is credible in its ability to keep inflation expectations well anchored and is not afraid of tightening policy when inflation has moved well above target
Elevated inflation, if left unaddressed, could cause a de-anchoring of inflation expectations, an increase in risk premia, greater price distortion and hence longer-term costs for the economy. Although at first glance, central banks face a dilemma - hiking interest rates to lower inflation at the risk of causing an increase in unemployment or focusing on the labour market and accepting the risk that inflation stays high for longer -, they can only choose between acting swiftly or face an even bigger challenge later to bring inflation back under control. Recent statements by officials of the Federal Reserve, the ECB and the Bank of England acknowledge the need to act but their decisions and guidance are very different and reflect the differences in the macro environment.
The global manufacturing PMI edged lower in April. The US and the UK recorded a small increase but there was a big improvement in Australia, Russia and even more so in Hong Kong. The euro area saw a decline but amongst its countries divergences trends were noted with an increase in France and the Netherlands and a decline in Germany and Italy. In China, Covid-19 infections led to a drop in the PMI to 46.0. The services PMI saw a significant decline in the US and a large improvement in the euro area. These developments are the mirror image of what we saw in manufacturing. France and Germany had better data but sentiment jumped in Italy and Spain. Japan had a moderate improvement. Data were significantly better in Brazil