Outlook for GDP growth, inflation, interest rates and exchange rates
The latest economic indicators updated on January 2 2023 and the coming calendar
During the press conference following the latest governing council meeting, Christine Lagarde insisted repeatedly that moving to a 50 bp rate hike versus 75 bp previously did not represent a pivot, adding that rates still have to rise significantly and at a steady pace. Consequently, the likelihood of a terminal rate higher than 3.00% has increased, which explains the jump in bond yields. The large upward revision of the inflation projections is probably another factor behind the hawkish message. Forecasting inflation several years into the future is a difficult task, even more so in the current environment
In its second estimate, the Spanish statistical institute (INE) raised slightly the harmonised inflation rate (HICP) for November from 6.6% y/y to 6.7% y/y. This is still a significant decline from the 10.7% y/y figure reported in July, as Spain now reports the smallest rate of inflation in the Eurozone.
UK inflation finally fell in November to +10.7% y/y (+0.4% m/m), compared with +11.1% in October (+2% m/m). Other good news is that core inflation is also falling, for the first time since September 2021 (-0.2 points, i.e. 6.3% y/y). In the face of still very high inflation, however, the Bank of England (BoE) Monetary Policy Committee (MPC) decided to raise its key rate further by 50 basis points, thus bringing it to 3.5%. The rise is less significant than in November (+75 bp) as the BoE must also reconcile it with the risk of recession.
From an economic perspective, 2022 will go down in history as the year in which elevated inflation made a surprising comeback forcing major central banks to start an aggressive tightening cycle. It is highly likely that in twelve months’ time we will look back at 2023 as a recession year, a year of disinflation, and a year in which official interest rates reached their terminal rate and stayed there. As usual, the list of ‘known unknowns’ is long. Energy prices might increase again after their recent decline, disinflation might be slower than expected, policy rates might peak at a higher level than currently priced by markets, and the recession might be deeper and longer than anticipated
US growth recovered significantly during Q3, but is expected to slow down during Q4 according to our forecasts. The labour market is still tight, but early signs of a slowdown are emerging. Headline inflation appears to have peaked, but core disinflation remains to be confirmed, which would forced the Federal Reserve (Fed) to continue its monetary policy tightening, even if it means pushing the economy into a recession in 2023. Looking at the budget, compromise will be key when the next deadlines approach, given the divided Congress following the mid-term elections.
It seems highly likely that for the eurozone, 2023 will bring an easing in inflation, a contraction in GDP and a peak in the ECB’s policy rates. The uncertainties lie in the scale of disinflation and of the recession, and in the level and timing of the peak in rates. According to our forecasts, the fall in inflation will be rapid on the surface (with headline inflation dropping from around 10% y/y in Q4 2022 to 3% in Q4 2023), but this will mask a slower fall in core inflation, which we expect to remain above 2% in a year’s time, from 5% at present. In the face of this persistent inflation, we expect the ECB to hike its deposit rate by 100bp, to 3%, by the end of Q1 2023 and then maintain this restrictive level throughout the year, despite the recession
Unexpected to say the least, +0.4% growth in German GDP in the third quarter should not distract from the bigger picture. While the power of the end of catch-up effects surprised the consensus which did not expect such dynamism in activity in the third quarter, there is no doubt that German growth drivers are fading one by one under the weight of an extremely unfavourable economic climate: record inflation, energy crisis, drop in global demand... After a last stand in Q3, it therefore seems unlikely that Germany could continue to post positive growth over the last three months of the year. While Germany’s entry into recession is almost confirmed, the question of how intense it will be is much more up in the air
The figure zero should define French growth in 2023. The carryover should be zero, due to a second half-year 2022 in which the positive performance observed in the third quarter should be cancelled out by negative growth in the fourth quarter (with a key contribution of a further drop in household consumption). The quarterly growth momentum recorded in 2023 is not expected to provide any further support. A further contraction in GDP is expected in the first quarter, mainly due to a further acceleration in inflation and the probability of lower inventories in companies. The upturn expected to occur from the second quarter should be moderate, limited to offsetting the drop in the first quarter
During the summer, the Italian economy continued to show a strong resilience against increasing uncertainty. In Q3 2022, real GDP rose by 0.5% q/q, benefiting from the recovery of services, while both manufacturing and construction suffered. Domestic demand more than offset the negative contribution of net exports. A wind of growth continues to blow on the Italian real estate market. In Q2 2022, residential sales recorded a +8.6% y/y growth, while house prices in the same quarter grew by 5.2% y/y. Although the carry-over for 2022 is 3.9%, the outlook for the Italian economy has become more uncertain. Households suffer from high inflation, with purchasing power declining, while firms have to cope with increasing costs of production.
Spain is now the eurozone country with the lowest inflation rate, standing at 6.7% in November. Government measures to curb the rise in energy prices are paying off, although the underlying CPI is still rising significantly. The slowdown in inflation is expected to continue in 2023, but the government will keep on providing significant support to the economy. The 2023 budget, discussed in parliament, extends most of the support measures until the end of next year. Faced with the rise in mortgage rates, Madrid eased repayment conditions for households via loan restructuring facilities while allowing for a temporary freeze on monthly payments
Belgian GDP avoided a dip in Q3, but our present forecast suggests Q4 could be worse. A short and shallow recession looks likely as record-shattering inflation is expected to gradually abate throughout 2023. Consumer spending and corporate investment remain sluggish, but the negative impact of energy prices on household budgets looks more limited than many had feared. Active government intervention played a big part here, but fiscal consolidation remains necessary.
After dynamic business activity during the first six months of the year, Austrian growth slowed very dramatically during Q3 2022, due to the economic downturn both nationally and internationally. GDP is not expected to rebound over the final months of the year and is even poised to stagnate in 2023. However, the downturn in business activity has not stopped the government from announcing an ambitious reduction in the public deficit, which would fall below 3% from next year. This would result in a sharp decrease in the public-debt-to-GDP ratio. These commitments appear to be credible, as the incumbent Green President, Alexander Van der Bellen, was easily re-elected on 9 October, offering political stability to the country following the debacle of the 2016 election.
Despite the significant rise in inflationary pressures, the Greek economy continued to grow quickly during the first half of 2022, at a rate of 4.1% over the period. Nonetheless, real GDP fell back 0.5% q/q in Q3 despite tourism activity holding up well and the labour market being resilient. Indeed, the unemployment rate dropped during Q3 2022 (-29k), hitting its lowest level since December 2009. Almost 80% of the rise in unemployment recorded during the economic crises in 2008 and 2011, which ran from autumn 2008 to spring 2013, was wiped out. As a result, even though it is still very high, the unemployment rate fell below 12% in October (11.6%)
UK growth contracted sharply in Q3, confirming that the economy has gone into recession. Household and business surveys confirm this fall in consumption and investment, which is likely to continue in the coming months. Faced with persistent inflation which continues to spread, the Bank of England is continuing to tighten its monetary policy, despite the economy entering recession. The simultaneous announcement of a support plan for households and fiscal consolidation measures by the new government should help in the fight against inflation while supporting the lowest income households.
Up until now the Danish economy has continued to impress, with a strong post-Covid rebound which has propelled its GDP well above its pre-crisis level, but the future now looks a lot less bright. If inflation had not yet been able to fully undermine household purchasing power due to significant job creation and a level of over-saving which helped to mitigate the impact, these one-off shock absorbers are coming to an end and real household income is expected to fall over the coming quarters. The government is remaining relatively impassive in the face of this brutal shock and the fiscal response remains very limited, with public accounts that are in surplus and likely to remain so. Public debt should converge towards only 32% of GDP by 2024..
An update of the GDP Growth and inflation data, interest and exchange rates
Following in the footsteps of the US inflation figures for October, Eurozone inflation also surprised favourably by coming in below estimates. Eurostat’s flash estimate of an annual rate of 10% in November was lower than the consensus figure of 10.4%. This raises hopes that Eurozone inflation has finally peaked, and indeed this looks likely. It is our scenario, but considerable uncertainty remains and caution is required.
The United Kingdom’s exit from the European single market and the customs union on 31 January 2020 caused a significant economic shock which has had an adverse impact on growth and inflation in the UK, particularly on foreign trade. Since 1st January 2021 and the coming into effect of the post-Brexit Trade and Cooperation Agreement (TCA), bilateral trade in goods between the United Kingdom and the European Union has fallen sharply. The United Kingdom has made changes which mean that some of its imported goods now come from countries outside the European Union.
Inflation seems to have peaked in June in the United States. The continuation of the momentum and the pace of disinflation will depend to some extent on easing of the tightness in the labour market, which continues to support wages. In October, the slight increase in the unemployment rate and the slowdown in nonfarm payrolls gains could well indicate the beginning of such easing. What about wage dynamics? According to the Atlanta Federal Reserve’s Wage Growth Tracker, the first signs of a slowdown are emerging. This indicator measures, on a three-month rolling average, the median percent change in the hourly wage of individuals observed 12 months apart. According to this indicator a slowdown in wage growth seems to be emerging, although this is still to be confirmed
Italy is facing an unprecedented and widespread surge in inflation and is unlikely to escape falling into recession this winter. Even though real GDP surprised on the upside in Q3 (+0.5% q/q according to initial estimates by the Italian National Institute of Statistics (Istat)), the barometer clearly indicates that the economic outlook is getting gloomier.
The US consumer price data for October have reinforced the view that disinflation -the narrowing of the gap between observed inflation and the central bank’s inflation target- has started. That conclusion seems clear as far as headline inflation is concerned -it has peaked in June- but we need confirmation that the decline in core inflation from the September peak is not a one-off. Core goods inflation has been moving down but core services inflation remains stubbornly high on the back of transportation services and shelter. What matters now for the economy and financial markets is the speed of disinflation because this will influence Fed policy, the level of the terminal rate and how long the federal funds rate will stay there
Harmonised inflation in the Eurozone surprised again unfavourably in October, reaching 10.7% year-on-year according to Eurostat’s preliminary estimate, compared to the Bloomberg consensus forecast of 10.2%. It was the second month in a row of such a large acceleration in prices (+0.8 points). This was not the only bad news: half of this acceleration can be attributed to core inflation, 0.3 points to food inflation and 0.1 points to the energy component. Inflation therefore continues to spread and to strengthen. While the persistent and common component of inflation (PCCI) seems to have peaked in May this year (at 6.4%), its decline since then (5.5% in September, latest available figure) is not yet visible in the other measures of inflation.
Inflation in Spain fell in October for the third consecutive month, from 10.7% in July to 7.3% in year-on-year terms. Although the detailed figures for October will not be available until 15 November, it is likely that, once again, the main driver behind this fall was energy prices, whose pace of increase has slowed noticeably this summer, although remaining high (22.4% y/y in September). The “Iberian exception”, which has been in place since the spring, and the capping of regulated prices on the energy market are paying off. The Spanish government has decided to extend these measures, along with the social bonus which allows electricity bills to be reduced by up to 80% for the least well-off households, until the end of 2023.
