Reflecting Jerome Powell's statement that it is time to adjust (i.e., loosen) monetary policy and subsequent action, it is also time to adjust fiscal policy in Europe and the United States, in the direction of tightening in both cases. This is a good time, given the context of monetary easing, falling inflation and positive economic growth. Even more than monetary easing, this fiscal consolidation must be gradual so as not to weigh too much on growth. Like the central banks that have been determined in their response to the inflationary shock, governments will have to show the same determination and perseverance in the coming fiscal consolidation efforts, given their necessity and significance.
Growth in the Eurozone is expected to stabilise at 0.3% q/q in the second half of 2024, before picking up slightly in 2025, supported by the cycle of interest rate cuts. However, the difficulties in industry, highlighted by the deterioration in PMI indices in September, and the uncertainty about the Chinese economy, increase the downside risks to our forecasts. A more adverse scenario, in which the manufacturing sector drags the rest of the economy along with it, is not the preferred one at the time of writing. Although less pronounced, the differences in dynamism between countries and sectors are expected to continue into 2025.
While there were signs of a rebound in German growth at the beginning of the year, the industrial recession was back from Q2 24, with a negative impact on the labour market that is now noticeable as the unemployment rate is rising. Against this backdrop and following the withdrawal of support for the purchase of electric vehicles in December 2023, households have increased their level of savings. However, there are still modest signs of a rebound, with a slight increase in demand. At the same time, the government’s awareness of the stalling of German industry could lead to the return of support measures.
Inflation and rising interest rates have resulted in the landing of domestic demand in the private sector overall (households and companies), without preventing French growth from maintaining a moderate pace (1.1% in 2023, 1.2% in 2024 according to our estimates), as a result of a drop in imports and therefore a positive contribution from net exports. Growth was also driven by service output (investment by companies in information and communications is even expected to overtake construction soon). This support is expected to drive stable overall growth in 2025, at 1.2%.
The recovery of the Italian economy continues, although at a moderate pace. In Q2 2024, real GDP rose by 0.2% q/q, supported by domestic demand, while net exports’ contribution was negative. The slowdown of investment reflected the decline of expenditure on dwellings, while machinery investment increased. Consumption moderately increased. Value added slightly accelerated in the services sector while continuing to contract in the manufacturing sector. The labour market has shown significant improvement since Q2 2021. In Q2 2024, the employment rate rose to 62.2%, a historical peak that, nevertheless, remains low in comparison with the main EU partners.
The Dutch economy avoided falling back into recession in the second quarter, thanks to a much smaller annual drop in exports and solid public spending, which was a promise from the new government. However, inflation is stronger than expected and will need to be monitored, as it could become a drag on private consumption. The outlook remains fine, nevertheless, but investments need to recover further in order to compensate for persisting labour shortages.
Our nowcast for the ongoing third quarter has Belgian growth at slightly below trend. Household consumption hasn’t accelerated much, while typical-election year dynamics inflate government spending. Gross fixed capital formation, dominated by firm investment, remains positive but the underlying trend is worrying. Belgian manufacturers seem especially far from a return to normal, while the spectre of fiscal tightening looms.
The presentation of the budget on 30 October will be the first real test for Rachel Reeves. The deteriorating situation of the public accounts and the September 2022 mini-budget crisis, which is on everyone's minds, are leaving the Chancellor of the Exchequer with little room for manoeuvre. UK growth is expected to slow in the second half of 2024 (+0.3% quarter-on-quarter). The two policy rate cuts by the Bank of England (BoE) that we expect in 2024 (August and November) would enable growth to come close to its potential level during this year and in 2025.
Less than 2 years after spiking to decades highs, inflation is back in the neighbourhood of central bank targets in most of the world. Yet it is too soon to declare victory, as there are still cross currents for economic policy-makers to navigate. As they have earned a good track record of it, and room to act, the year-ahead baseline scenario is fairly benign for both advanced economies and emerging markets, with gradually easing financial conditions (from lower interest rates and a likely weaker US dollar) allowing activity to stabilize around trend growth.
GDP growth, inflation, exchange and interest rates.
The September FOMC meeting kick-started the Fed’s easing cycle with a significant 50bps cut in the Federal Funds Target Rate, leaving it at +4.75% - +5.0%. Unusually, this large step was taken even as the US economy remains strong, and explicitly with a view to keeping it so. Effectively, macroeconomic conditions having induced a shift in the Fed’s priorities towards the ‘maximum employment’ component of its dual mandate, while still not declaring mission accomplished on the inflation side
GDP growth, inflation, interest and exchange rates.
We expect September 17-18 FOMC Meeting to result in a 25bps decrease in the Federal Funds Target Rate to 5.0% - 5.25% - barring a huge surprise. This move will launch the beginning of an easing cycle for monetary policy. The combination of improved data and outlook for inflation and the ‘unmistakable’ softening of the labour market leads to a shift in the Fed’s priorities, paving the way for rate cuts. A few thoughts beyond the direction change:
The household savings rate in France has risen further, up from 17.6% of households' gross disposable income (GDI) in Q1 2024 to 17.9% in Q2 2024, according to the INSEE, i.e. 1 point more in a year. This is also an early sign of an upward trend underway in the Eurozone. While the figures for Q2 are not yet available, the Q1 figures pointed to a savings rate 3 points higher than its pre-COVID level (at 15.4%).
While the date of the Fed's first rate cut is now foreseeable (it will be at the FOMC on 17-18 September), everything else remains uncertain: the size of the cut, as well as the overall extent of the easing cycle and the timing of the cuts. Developments on the US labour market are key in this calibration. In terms of inflation, significant progress has been made regarding the return to price stability on both sides of the Atlantic, but the battle is far from won. This calls for caution in the monetary easing that is beginning
In August 2024, French inflation is expected to fall back below 2% year-on-year for the first time in three years (August 2021). This disinflation is mainly linked to energy prices and is expected to increase further at the start of 2025 for the same reasons (expected drop in electricity prices). By contrast, inflation in services, which has been impacted by an Olympic effect in particular, is expected to remain high in the short term, but will not prevent further disinflation.
Key figures for the French economy compared with those of the main European countries, analysis of data on the population and the French labour market, activity by sector, publication administration figures, inflation, credit and interest rates, corporate and household accounts.
While recent economic data across the board suggest that growth was strong in Q2, leading indicators (business climate, household confidence) were more mixed in June, pointing to a more difficult Q3. This is particularly the case in the US, where even the ISM non-manufacturing index deteriorated sharply in June, while in Japan and the UK, growth should return to a more normal level after a very favourable Q2 (and benefiting from rebound effects in Japan, after a more difficult Q1).
The difficulties in the Eurozone manufacturing sector are intensifying. Industrial production fell again in May, by -0.6% m/m (-0.8% m/m for the manufacturing index). The deterioration in the PMI indicators for the euro area in June does not bode well for Q3, with a fall in the manufacturing index (-1.5 points to 45.8) and a decline in all the subcomponents (production, employment, new orders, stocks of purchases, delivery times). The input price index (which is not included in the calculation of the aggregate manufacturing index) is back above the expansion zone for the first time since February 2023. This is consistent with the trend in producer prices, for which the monthly decline has been slowing for several months and is now close to zero
The French economy is once again feeling the weight of economic uncertainty, as shown by the rebound in the Banque de France's uncertainty indicator, which in July reached its highest level since autumn 2022 (energy crisis). This could weaken a business climate that is already a little less favourable in France (composite PMI at 48.8 in June) than in the eurozone (PMI above 50 for the past four months).
Italian inflation stabilised below the 1% mark in June (at 0.9% y/y) due to the still significant deflation in the energy component (-8.6% y/y), and the slowdown in food prices (2.1% y/y in May; -1.8 pp over three months). Although the producer price index is still negative year-on-year (-3.5% in May), it is beginning to strengthen on a monthly basis (+0.3% m/m), suggesting that the disinflationary phase in consumer prices could be reversed over the coming months.
