For economists and central bank watchers, the ECB conference in Sintra (Portugal) and the Federal Reserve conference in August in Jackson Hole are the highlights of the summer season. As always, the presentations and panels at the Sintra conference were very stimulating but also sobering. Disinflation is too slow, there are upside risks to inflation compared to the pre-pandemic era, policy rates will have to remain elevated and economic forecasting is more challenging than ever.
In the major OECD economies, the slow pace of disinflation is expected to continue, while the slow slowdown in growth will eventually lead, because of the monetary tightening (particularly rapid and significant), to a recession in the United States and stagnation in eurozone GDP. Various supportive factors should limit the extent of the reversal, but the ensuing recovery would be equally limited. The slow convergence of inflation towards its 2% target would force central banks to maintain a restrictive policy despite the start of rate cuts in the first half of 2024.
Uncertainty about US economic policy, based on media coverage, fell in June after a rebound in May. The European Commission’s economic uncertainty index fell in June, continuing its decline since October 2022, as uncertainty in the various sectors of activity decreased, except in industry, where the index remained stable.
GDP growth, inflation, interest rates and exchange rates
Which country is the most exposed to recession? Is it the United States or the eurozone? The first answer that comes to mind is: the eurozone. It has, indeed, “technically”, already slipped into a recession in view of the double fall in GDP in Q4 2022 and in Q1 2023. But, for now, this recession looks to be only “technical”: indeed, the contraction in GDP is small and not widespread across all growth components or among eurozone members.
The significant and fast paced monetary tightening by major central banks and the prospect that more is to come raise the concern of a monetary ‘overkill’. This could happen due to a non-linear reaction of economic agents to an umpteenth rate increase. Several factors can play a role in this respect: negative animal spirits, debt levels and their characteristics, asset valuations, bank lending, capital markets. This calls for increased gradualism and, at some point, taking a pause whilst insisting that this doesn’t represent an end to the tightening cycle.
Global export volumes fell sharply in April, a fairly logical correction after the strong growth in the previous month, linked in particular to the catch-up effects subsequent to the end of the lockdown in China.
In June, the main OECD economies experienced divergent trends, raising the question of the tipping point between a situation where growth continues – with inflationary pressures requiring further monetary tightening – and another where it slows down further and where the fall in inflation means that an end to rate hikes can be envisaged.
What characterizes the current business cycle? Whether it is the monetary squeeze, the growth slowdown or disinflation, the word that springs to mind seems to be "slow". Moreover, the prospects for recovery, which will mark the beginning of a new cycle, promise to be characterized as slow as well.
The global composite PMI rose to its highest level in a year and a half in May at 54.4 compared with 54.2 in April, the fourth increase in a row. However, this improvement in global activity conceals a clear disparity between the brisk momentum of the services sector and the weakness of the manufacturing sector.
The European Commission’s economic uncertainty index fell in May, continuing the decline since October 2022, due to the reduction in uncertainty in various business sectors, apart from construction, which saw a marked rise.
Rates and exchange rates - GDP Growth and inflation
The reopening of the Chinese economy at the end of last year has finally had its effects with a few months’ delay. Exports from China jumped 19.8% m/m in March, according to preliminary figures released by the CPB.
In April and May, there was a relative deterioration in the main OECD economies, with some divergences in the magnitude and extent of this deterioration across the economies. In Europe, the deterioration observed in the manufacturing sector over the past few months is beginning to spread to services, where confidence indices have begun a downward trend. In the United States, the ISM non-manufacturing rose moderately in April, compared to an ISM manufacturing index below 50 for the sixth consecutive month.
Biodiversity loss, soil moisture reduction, food insecurity, migration increase: report after report, the IPCC (Intergovernmental Panel on Climate Change) warns of the consequences of global warming and the need to keep it within the sustainable limit of 1.5°C to 2°C compared to the pre-industrial era.
April was marked by the stabilisation of the Purchasing Managers Index (PMI) for the manufacturing sector, after a slight decline in March.
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.
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.
