Persistent inflation and the rapid and sustained rises in interest rates are hitting the US economy hard. However, business climate surveys are recovering, albeit modestly, and consumer confidence has improved for the second consecutive month. Business climate indices rebounded in September, although without moving back into growth territory. The composite PMI recovered significantly (+4.7 points compared to August) to stand at 49.3, mainly driven by the strong growth in the services sector PMI (+5.5 points, to 49.2) and, to a lesser extent, by a slight improvement in the manufacturing PMI (+0.2 points, to 51.8).
Dark clouds are continuing to gather over the Eurozone economy. The first set of data available for September is not positive and this can be seen in our Pulse. Looking at the survey data, the blue area (recent conditions) is shrinking when compared to the dotted line (conditions four months earlier) and even, on some indicators, when compared to the grey dodecagon (the long-term average). The opposite is true for the inflation data. In fact, inflation reached a new level, at 10% y/y in September according to Eurostat’s preliminary estimate. Not only did inflation reach double figures – which was predictable, but still bad news – but its 0.9–points rise compared to July was broad-based across all its main components.
Inflation has been the dominant economic theme for months, but, under the influence of aggressive monetary tightening, one can expect this won’t last. At the same time, recession concerns are mounting. Central bankers acknowledge that their action may cause a technical recession, a huge majority of US CEO’s expect a recession and consensus forecasts show an increased recession risk in the US and even more so in the euro area. The recession narrative should lead to a wait-and-see attitude, of putting spending and hiring decisions on hold and creates a mutually reinforcing negative interaction between hard data and sentiment. A key condition for this to end is growing belief that central banks will have done their job and can afford to stop tightening
Following a second contraction in its GDP in Q2, the outlook for the US economy is at least uncertain. Inflationary pressures are showing signs of easing, but the pace of disinflation could be longer than expected. While consumer confidence recently paused its downward trend and in fact recovered slightly in August, business surveys show a sharp decline in sentiment, particularly in the manufacturing sector. The Federal Reserve has continued the rapid rise in its fed funds rates, which are now at restrictive levels.
The recovery in activity since the end of the lockdowns imposed in Shanghai in the spring has been very gradual. It picked up in August, notably supported by public investment and tax measures, but it is likely to lose steam again in September. As exports begin to suffer from weaker global demand, the continuation of the zero-Covid strategy and the serious crisis in the property sector continue to weigh heavily on confidence, private consumption and investment. An easing of the health policy and more wide-ranging actions to support the property market seem to be the only measures capable of lifting the Chinese economy out of its current gloom.
The Yen continued to plunge this summer, reaching its lowest level against the dollar in 24 years. The Bank of Japan (BoJ) is keeping its yield curve control policy unchanged, exacerbating the gap with other major central banks and, consequently, downward pressures on the currency. This depreciation has also led to an unprecedented widening of the trade deficit. Although the pace of inflation is significant for the country (3.0% y/y in August), it remains under control and at a lower level than in 2014 and the start of the Abenomics programme. Even if it’s tightening, there is still room for manoeuvre for the BoJ. However, with a GDP level almost 2.5% below its 2019 summer level, Japan remains the G7 country where the upturn in activity has been the least pronounced since two years.
The current unprecedented combination of shocks (inflation, health crisis, geopolitical issues, energy crisis, climate, monetary issues) is likely to overburden the Eurozone resilience and push the region into recession over the coming quarters. The deterioration in confidence surveys this summer provides an early indication of this likely outcome. However, we expect the recession to be limited in scope, in large part due to budgetary support. This recession should be followed by a moderate recovery as the various shocks start to ease. Faced with the continued surge in inflation, the ECB has moved up a gear
The question is no longer whether or not Germany will slide into recession, but rather when and to what extent. The surprising resilience of German GDP in the 2nd quarter should not disguise the significantly worse outlook for the rest of the year. With continuing supply constraints, the new risk of energy shortages, rising production costs and high and widespread inflation that severely reduces household purchasing power, Germany is unlikely to avoid a fall in its GDP. However, the extent of the downturn should be limited.
French growth was surprisingly up in the second quarter (+0.5% q/q), supported by the positive impact of the lifting of Covid-19-related restrictions on tourism and leisure. The rest of the economy was almost flat according to our estimates (+0.1% q/q) due to accelerating inflation. After a negative first quarter (-0.2% q/q, including "after adjustment"), this indicates a narrowly avoided recession. Looking ahead, however, the deterioration in business surveys, the impact of energy prices on businesses, the drought and the decline in electricity production increase the recessionary risk.
During the first half of 2022, the Italian economy has gradually gained strength. In Q2 2022, the real GDP was 1.1% higher than in Q4 of 2019. The carry-over for 2022 is 3.5%. The recovery that resulted was widespread in a variety of sectors. Construction continued to grow, recording a robust increase in comparison with the pre-COVID level, while both manufacturing and services increased as well, benefiting from the recovery of tourism. The overall outlook for the Italian economy has become more uncertain. Households and firms are extremely cautious. In the three months ending in July, industrial production fell by more than 1.5% q/q. The value of retail trade continued to rise, while the volume of sales declined, suffering from the acceleration of inflation.
Spain is unlikely to avoid a difficult winter. Although its economy is structurally less vulnerable to energy shortages, the inflationary shock is severe and is not slowing down, with an inflation rate of over 10% in August. The rise in non-energy prices is amplifying relentlessly. Despite government action, the decline in purchasing power for Spanish households will be among the biggest in the Eurozone. Although tourism is likely to have helped business to cope with the third quarter, we are expecting a contraction in the fourth quarter of 2022, which is likely to continue through the winter. Job creation was strong again this summer, but opinion surveys are also pointing to a downturn on the way.
Belgian GDP grew by 0.2% in the second quarter of this year. Private consumption continued its upward trajectory in the first half of 2022 but is expected to slow down as inflation remains at an all-time high. Higher labour and energy costs are weighing on firms, with investment expenditures once again below pre-pandemic levels. A recession as from the end of this year looks unavoidable. Active fiscal policy should ensure it remains a shallow one but the cost to public finances will be sizeable.
With a relatively limited risk of energy shortages, Portugal should record some of the largest economic growth in the eurozone this year. A number of favourable factors are driving these growth levels. There has been substantial carry-over growth from 2021 and real GDP rose sharply in Q1 (+2.4% q/q), before stabilising in Q2. The recovery in tourism has also boosted business activity this summer. Despite the aid measures for households and businesses, which the government estimates are worth EUR 4 billion so far in 2022, there should be a slight surplus on the primary budgetary balance for this year
Finland, like other Nordic countries, has so far shown itself to be particularly resilient to the current financial shocks, but the clouds are gathering over the “Land of the Midnight Sun”. After five consecutive quarters of growth, buoyed by robust domestic demand, activity is expected to slow significantly in the second half of 2022 due to the persistent geopolitical tensions, tightening of financial conditions and price rises that are impacting on corporate margins and on the purchasing power of households. In an increasingly less favourable economic environment Finland can, nonetheless, be pleased with its structural efforts and in particular with the success of its housing policy
UK growth contracted slightly in Q2, but the economy should not enter a recession before Q4. On the one hand, the labour market continues to operate at full employment, which will partially absorb the sharp impact of inflation on purchasing power. On the other hand, the new government plan to support households and businesses should mitigate future energy price increases. Faced with persistent inflation, the Bank of England (BoE) is further accelerating its monetary normalisation, at the risk of precipitating a contraction in the economy.
After eight years in opposition, the conservatives have returned to power in Sweden in rather unfavourable circumstances. Although economic activity has proved resilient so far, it is showing clear signs of a slowdown. And faced with rising inflation, the population is demanding more support from the state authorities. Furthermore, the government will quickly need to adopt a position on the NATO accession process before assuming the presidency of the European Union from 1 January 2023. The difficulty will be managing to form a coalition government spanning the Liberals (on the centre-right) to the Sweden Democrats (far-right).
Switzerland differs from other European countries in that it has significantly lower inflationary pressures, protected as it is by its strong currency and by resilient business activity which should continue to grow for the rest of 2022 and during 2023. Although the Swiss National Bank (SNB) is likely to argue that 3.5% inflation year-on-year in August is a reason to raise its key rate by 75 bps on 22 September, and so exit from its policy of negative interest rates, it is unlikely that this monetary tightening will last over the longer term, as inflation is already showing signs of slowing down.
Despite a tight labour market, the UK economy is showing clear signs of a slowdown in growth as inflation hits a 40-year high. According to the monthly GDP estimate published by the ONS, on a three-month moving average UK growth was flat in July, marginally below expectations (+0.1%). This zero figure masks more substantial monthly changes: after rising in May (+0.4% m/m), GDP fell in June (-0.6% m/m) before recovering slightly in July (+0.2% m/m). In July, growth in the services sector (+0.4% m/m) was largely offset by new contractions in industry (-0.3%) and construction (-0.8%).
In many developed countries, housing prices have risen very sharply since the Covid-19 crisis. In the United States they jumped 37% between the 4th quarter of 2019 and the 2nd quarter of 2022. In Germany and the United Kingdom, the increases have also been significant and were 23.8% and 18.6% respectively over the same period. The increases in Italy (+7.4%) and Spain (+10.8%) were more restrained, while France (+14.1%) and Japan (+15%) were somewhere in between. Can such price increases be justified in terms of fundamentals or are they more indicative of a real estate bubble? In order to quantify this, the Dallas Fed publishes a housing prices exuberance index each quarter
Our Pulse shows an improvement in Chinese economic conditions over the period June–August 2022 compared to the previous three months (widening of the blue zone compared to the dotted zone). In fact, the very strict lockdown measures imposed in the spring (in Shanghai in particular) started to be lifted at the end of May, allowing activity to resume. The acceleration in economic growth has remained very gradual. However, it surprised positively in August, both in industry (+4.2% y/y after +3.8% in July and +0.6% in Q2 2022) and in services (+1.8% y/y after +0.6% in July and -3.3% in Q2).
With Gazprom announcing on 2 September that gas deliveries via NordStream1 would be interrupted until further notice due to alleged oil leaks discovered during maintenance work, the increase in deliveries promised by the Russian company via other pipelines (such as those crossing Ukraine) will only marginally compensate for the shutdown of NordStream1. The likelihood of power cuts this winter is increasing even though gas inventories are expected to be replenished in early November.
Inflation in Spain shows no signs of abating. Consumer price inflation remained above 10% y/y in August, at 10.5% (national measure). Although slightly lower when compared to July (10.8% y/y), this decline was mainly due to a fall in private transport costs (-3.5% over one month), the result of lower fuel prices at the pump. Conversely, the increase in food prices (and non-alcoholic beverages) accelerated, by 0.3 of a point to 13.8% y/y, with increases seen in dairy products, bread, and corn. The underlying measure (which excludes energy and perishable foods) also rose, from 6.1% y/y to 6.4% y/y. Prices also continue to be very dynamic in the property sector.
The downward trend of the manufacturing PMI has continued in August. In most advanced economies, the index is below 50, which corresponds to a contraction of activity in the manufacturing sector. A significant deterioration could be noted in the UK last month. The Chinese index has also dropped below 50. The drop in terms of new orders has been particularly large since the month of May. It is also widespread. In the euro area and most of its member countries as well as in the UK, the index has moved below the 46 mark. The readings are also very low in Mexico, the Czech Republic, Poland and Turkey. The situation has also deteriorated in China.
The French economy sprung a pleasant surprise in view of the headwinds that have been picking up since the start of 2022. Growth was 0.5% Q/Q during Q2, mainly due to the upturn in tourism and leisure business activity after COVID restrictions were lifted from March onwards. However, inflation continued to have an impact, as seen in the further fall in consumer purchasing power during Q2 (-1.1% Q/Q, following on from -1.6% during Q1). This inflation hit 6.1% Y/Y in July before falling back to 5.8% in August (according to the French National Institute of Statistics and Economic Studies (INSEE) national measurements).
Cradle of social democracy, Sweden is facing a possible breakthrough of the far right. Only 12 years after entering Parliament, with only 5.7% of the vote, the Sweden Democrats (SD, far right) now threaten traditional political forces. After a campaign marked by debates on crime in Sweden, on 11 September, the current government coalition led by the Swedish Social Democratic Party could fail to secure a third consecutive term, following on from its wins in 2014 and 2018
