Central banks' decisions influence markets, households and businesses. It is therefore necessary to understand how they will react to incoming data. The Federal Reserve and the ECB have similar reaction functions but offer different guidance because of the differences in terms of economic environment, particularly with respect to real interest rates.
GDP growth, inflation, interest rates and exchange rates
Central banks continue to face high inflation, which has spread to almost all items in the consumer price index (CPI). While food inflation is still one of the main drivers of the CPI increase, the momentum in services continues to be strong.
Traditionally, monetary policy focuses on price stability and fiscal policy on other objectives. When inflation is well below (above) target on a sustained basis, this separation of roles implies that monetary policy may need to become extremely accommodative (restrictive). Consequently, interest rates have a large cyclical amplitude, which may have undesirable consequences for the economy and put financial stability at risk. Simulations show that a coordinated approach between monetary and fiscal policy reduces the optimal cumulative amount of rate cuts (hikes). However, putting this into practice would probably be very challenging.
Uncertainty over US economic policy, which is based on media coverage, rebounded in March. The European Commission’s economic uncertainty index declined in April thanks to the easing of uncertainty in the various business sectors.
GDP growth, inflation, interest and exchange rates
Price stability, financial stability and fiscal sustainability are part of the necessary conditions for the balanced development of an economy in the longer run. They can be considered as pillars on which the ‘economic house’ is built. Weakness or fragility of one pillar -e.g. inflation well above target, overvalued asset prices or a high and rising public debt ratio - may impact the solidity of the other pillars and weaken the overall structure. This gives rise to a debate about the nexus between these three conditions. Given these interactions, it is important that each policy -monetary, fiscal, financial stability oriented- is conducted in a way that takes into account its influence on the other objectives. This should enhance overall economic stability.
GDP growth, inflation, interest rates and exchange rates.
In March, economic conditions in the major OECD economies remained favourable. While in the US, the growth momentum is continuing, Europe is still benefitting from catch-up effects in the energy-intensive sectors (which had slowed down their production during the winter), and in transport equipment (which is benefitting from reduced supply difficulties). This has favoured employment, whose dynamism has improved (probably temporarily) in Europe compared to Q4 2022.
In an interview with the press in 2021, the President of the European Commission, Ursula Von Der Leyen, stated that "growth and CO2 emissions [were] not necessarily linked", citing the European Union (EU) as an example. Since 1990, the EU has in fact reduced its greenhouse gas emissions by 25% while increasing its gross domestic product (GDP) by 60%. Although this is true at the level of the EU-27, it is hardly transposable on a global scale.
After last year’s significant depreciation versus the dollar, the euro has found a new strength. Key factors are the reversal in the current account balance, which after moving into negative territory last year is back into surplus, and, since the autumn of 2022, the narrowing of the 1-year interest rate differential with the US.This reflects the view that the Federal Reserve is approaching the end of its tightening cycle whereas the ECB still has more work to do. We expect that this factor will continue to drive the exchange rate in the coming months. Moreover, there is also a higher likelihood that the Federal Reserve will cut rates before the ECB does
On 5 April, the World Trade Organisation (WTO) released its revised outlook for 2023 and its first forecasts for 2024. It is now projecting world exports in volume to grow by 1.7% this year, up from its October 2022 forecast of 1%. Although this is still a mild increase, the WTO is expecting a rebound in 2024 to 3.2%.
GDP growth, inflation, interest rates and change
In Western Europe, in Q4 2022, the number of business insolvencies returned to levels close to those seen at the end of 2019. This increase conceals national disparities. The United Kingdom and Sweden saw it earlier, as weakening growth and tightening of monetary policy occurred earlier in these countries (and more significantly for the United Kingdom) than in the eurozone. In the eurozone, the increase in insolvencies remains partial, but is likely to continue.The situation in the various sectors reflects these differences. As a result, the increase is almost across all sectors in the United Kingdom and Sweden, particularly in construction and even more so in trade.In France, business insolvencies are approaching their pre-Covid levels but are still 6.1% lower in Q1 2023
Evidence of falling housing prices remains patchy. After a sustained rise throughout 2021, residential housing prices in the main European countries continued to resist the tightening of credit conditions in the fourth quarter 2022, with the notable exception of Sweden and Germany. A generalisation of real estate price declines in 2023 is a significant possibility.
Manufacturing PMI figures were mixed in March. After rebounding in February, new export orders (table 2) dropped in March, due to sharp declines in Vietnam and China, and a slight fall in the United States and the UK. The normalisation of supply chain conditions has also carried over to input prices.
Energy inflation continues to slow as a result of falling prices. Nevertheless, underlying pressures are rising in the euro area, and some alternative measures scrutinised by the ECB – the weighted median and the HICP – reached a new high. In the United States, core inflation slowed slightly in February. However, should the pace of month-on-month increase continue, it will remain in line with an inflation level above 3%. UK inflation (total and core) picked up slightly in March.
The recent difficulties faced by some US regional banks have reignited the debate about a potential conflict between pursuing price stability and financial stability at the same time
Although the latest figures show a few divergences, the overall trend in March is towards a slight reduction in uncertainty.The European Commission’s economic uncertainty index declined slightly in March, continuing its easing trend since October 2022, in the various business sectors. The only exception is household uncertainty, which has picked up slightly.
Recent data in the US show a resilient economy despite the significant and fast tightening of monetary policy. In the Eurozone, the services sector is a source of resilience. Frustratingly for central banks, inflation has also been resilient. This would call for a strong message of further monetary tightening, were it not that uncertainty about the outlook is high. More than ever, central banks need a robust strategy which takes into account a range of possible outcomes. As a consequence, the message from the FOMC has taken a dovish twist. Reading between the lines, the ECB’s message is also softening, as witnessed by the strong emphasis on data-dependency and the role of financial conditions.
International trade data show quite clearly that the slowing of activity has been accentuated over recent months. Global export volumes, have continued to fall, according to the latest figures (December 2022). Health restrictions in China, which were only relaxed in mid-December, weighed on this dynamic. Nevertheless, global exports saw a 2.6% increase over the whole of 2022, relative to 2021.
In February, economic news on the growth front continued to be quite positive in the major OECD economies, while developments on the inflation side were negative.
