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
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.
The tight US labour market plays a crucial role in the effort of the central bank of bringing inflation back to target. Slower growth in labour income should lead to slower demand growth, whereas smaller wage increases will ease pressure on corporate profit margins and reduce the need for companies to charge higher prices. The labour market is characterized by a dynamic interaction between job openings, unfilled vacancies, voluntary departures (quits) and layoffs. In the US, unfilled vacancies and the quits rate have started to decline and one should expect that this dynamic will gather pace, causing a slowdown in wage growth. The question remains to what extent this will bring down inflation, which is why the Federal Reserve’s policy is completely data-dependent.
In recent months, the huge and rising gap between observed and target inflation has confronted central banks with an urgency to act. It could be called the panic phase of the tightening cycle. What followed was a swift succession of significant rate increases. Tightening was frontloaded, rather than gradual, to avoid an unanchoring of inflation expectations. This perseverance phase will be followed by a long wait-and-see attitude once the terminal rate -the cyclical peak of the policy rate- will have been reached. During this patience phase of the monetary cycle, the central bank will monitor how inflation evolves. With the risk of further rate hikes having declined, the government bond market should stabilize, which can have positive spillovers to other asset classes
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.
There is a large consensus that 2023 should be a year of disinflation. Monetary tightening will play an important role in that respect. However, it is difficult if not impossible to estimate when and at which level of official interest rates, inflation will have sufficiently converged to target. This explains why the Federal Reserve and the ECB have decided to frontload their rate hikes. It should reduce the risk of inflation surprising to the upside. A lot will depend on how inflation expectations evolve. Recent research shows that firms use price information to which they are directly exposed to form an opinion of future, aggregate inflation
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).
Recent economic data paint a picture of increasing concerns about the economic outlook. In the US, high inflation and rising interest rates play a key role. In the euro area, the same factors play a role -although interest rates are still below those in the US- but skyrocketing energy prices and gas supply disruption are additional forces that should drag down growth. Easing price pressures in business surveys are a hopeful development but selling price expectations remain nevertheless exceptionally high given the weakening of order books. This could point to input price pressures that force businesses to charge higher prices to protect their margins. It is to be feared that slowing demand will make this increasingly difficult, forcing companies to cut back on investments and new hirings
The US labour market continues to perform well. The unemployment rate stood at 3.7% in August, up slightly from 3.5% in the previous month. Total nonfarm payroll employment growth is slowing down but remains significant (+315k m/m), particularly in professional and business services, health care, and retail trade. The labour market’s resilience to the slowdown in growth is an important element in mitigating the impact of the rising cost-of-living.
An exceptional response to exceptional circumstances. There is a high probability that the ECB will raise its policy rates by 75 basis points at its meeting on 8 September. The fact is that the ECB has little choice but to respond with extraordinary measures to the continuing surge in inflation, despite the increased risk of recession. This is putting into practice the hawkish statements of Jackson Hole and the unconditional determination displayed to maintain price stability.
Over the next five years, French economic policy will have to continue to deal with structural issues, such as full employment, the delay of companies in terms of robotisation, the competitiveness of companies and the place of industry. It will most likely also continue to focus, at least in the short term, on supporting household purchasing power, as it has done since 2019. These projects, which will have to be carried out in parallel, will have to be reconciled with the cost of the ecological and energy transition against the background of public debt that has already risen sharply and interest rates that are moving higher, albeit in a controlled way.
After 2021, a year when wage negotiations were difficult against a backdrop of a fragile and uneven economic recovery, wage increases should be much higher in 2022 but insufficient to compensate workers for high inflation. The country’s most powerful union, IG Metall, has obtained a wage increase which has not been seen in the metalworking sector for 30 years: +6.5%. However, this increase should be put in perspective, since the agreement covers 18 months, bringing the annual growth rate to +4.5% in 2022. Salary negotiations in Germany are still mostly carried out at a centralised level (by industry or sector). The shift in decentralization in the 1990s mainly enabled enterprises to break out of sectoral agreements in exceptional circumstances (e.g
Since 8 July, a new governmental scheme has offered an ‘anti-inflation’ cheque of EUR200 per person to 2.7 million of the most vulnerable Spanish households. This measure is part of a total package of EUR9 billion, approved by the authorities at the end of June. This also includes another cut in VAT on electricity (from 10% to 5%) and a cut in travel costs. These steps to support households’ purchasing power are welcome as inflationary pressures continue to rise.
The downward trend of the global manufacturing PMI continued in June. The index dropped in the US and declined in the euro area to respectively 52.7 and 52.1, which brings us close to the crucial 50 mark. The various euro area countries for which data are available all recorded lower numbers. Data were also weaker in the UK and Japan. Australia, Mexico and, in particular, China saw an improvement.
Emerging countries have recently faced a series of unexpected and severe shocks that will significantly dampen their economic performance in 2022. Global inflation has increased due to rising commodity prices and world supply disruptions resulting from the conflict in Ukraine. The lockdowns in China’s industrial regions during the spring have aggravated supply problems and further worsened the global economic outlook. Moreover, monetary policies have tightened in most countries, while external financing conditions have also deteriorated due to the weakening in global investor sentiment and US monetary policy tightening. Emerging markets have already faced a bout of large capital outflows since the beginning of the year
On the economic front the eurozone has seen a succession of similar-looking months, with inflation continuing to rise and confidence surveys continuing to fall to different extents. Although there is a clear deterioration in the economic situation and outlook, its scale and duration remain uncertain. A recession is getting more likely but is not (yet) a certainty, first because activity levels remain strong and not all the economic indicators are flashing red (particularly when it comes to the labour market) and secondly because growth has some tailwinds or, at the very least, shock-absorbers.
Inflation has continued to accelerate, at 5.8% y/y in June, and has not yet reached its peak. Most significantly, the energy component saw a further monthly rise of 5.3% in June, having already risen by 9% in March. Not only had the initial shock not yet fully passed through into other prices (food, manufactured goods, services), but this new increase signals a further acceleration in inflation, particularly in the food component which suffered the most from the initial shock (1.4% increase month-on-month and 3.1% over 3 months): In June, this food index has increased by 5.7% y/y, below July 2008’s 6.4% peak, but should rise above and reach 9% in December 2022, according to our forecasts.
The level of activity in the US and the euro area is very high but growth has already slowed down significantly and quarter over quarter growth should remain low for the remainder of the year. Worries about the cyclical outlook are on the rise due to a combination of elevated inflation, geopolitical uncertainty and monetary policy tightening. Survey data on input prices and delivery times have eased but the levels are still very high. Wage growth remains strong in the US and is picking up in the euro area, creating concern that inflation would decline more slowly than expected. In addition, assessing the true state of demand has become very difficult.
Inflation’s unexpected rebound in May forced the Federal Reserve (Fed) to accelerate the normalisation of its monetary policy. In mid-June, the Federal Open Market Committee (FOMC) decided to raise the fed funds rate by 75 basis points (bp). At the same time, the Fed began to shrink its balance sheet through Quantitative Tightening (QT). For the moment, the US economy is holding up well, supported by robust fundamentals such as employment. Yet activity is beginning to slow under the impact of tighter lending conditions and deteriorating global economic prospects. The US economy will come under fierce pressure as it navigates towards a hard or soft landing.
Since early 2022, inflation has been rising, albeit moderately, for the first time since 2014, while growth contracted in Q1. The yen has depreciated sharply due to the Bank of Japan’s very accommodating monetary policy, which is out of step with the other major central banks, who have already begun to tighten their monetary policy. In June 2022, BoJ Governor Haruhiko Kuroda still thought it was “necessary” to maintain a yield curve control policy to boost core inflation to a “stable and sustainable” level. Yet currency depreciation aggravates imported inflation and further erodes household purchasing power. A few weeks before the legislative elections of 25 July, the government is likely to reinforce measures to support household purchasing power.
Until May, Eurozone growth has been relatively resilient to the series of shocks that have swept the region, but its pace should slow more significantly in the months ahead. We cannot rule out the possibility of a recession, even though that is not our base case given the numerous sources of growth: post Covid-19 catch-up potential, surplus savings, investment needs and fiscal support measures. Our scenario appears to signal stagflation (inflation will be much higher than growth in 2022 and 2023), but with the big difference that the unemployment rate is not expected to rise much. The ECB is preparing to begin raising its key policy rates to counter the inflationary shock. We are looking for a cumulative 250bp increase in the deposit rate, bringing it to 2% by fall 2023.
Germany is one of the Eurozone countries hit hardest by the Russia-Ukraine war, which is leading towards feeble growth prospects and high inflation. German GDP is expected to barely increase by 1.3% in 2022, compared to a Eurozone average of 2.5%. Average annual GDP growth will remain 0.9% below the year-end 2019 level. At the same time, inflation is expected to reach 8.1% in 2022, driven up by high energy prices. Between the minimum wage hike promised by the government and expected wage increases in many sectors, wage growth should accelerate strongly in 2022, but may not be sufficient to offset the inflationary shock.
The French economy is stuck between three developments with different effects: an inflation shock that is denting consumer spending, a negative supply shock (supply constraints in industry) and the lifting of public health restrictions (benefiting growth as of the second quarter, having held it back in the first quarter). Government measures that have limited inflation were unable to prevent negative growth in the first quarter. However, the positive impact of the lifting of public health restrictions and a rebound in purchasing power should allow for a recovery towards positive growth in the third quarter (+0.3% q/q).
With an energy mix comprised of nearly 90% fossil fuels, the Netherlands have been hit by the full brunt of the sharp rise in oil and gas prices since the outbreak of the Russia-Ukraine war. As a result, the Netherlands has one of the highest inflation rates in Europe. Even so, household consumption is resilient, and the majority of companies esteem that business will remain vigorous in the months ahead. Thanks to this strong performance, the government has been able to focus on a limited series of support measures while continuing to reduce the debt of public administrations. Yet the Netherlands also faces another type of inflation that is just as alarming: house price inflation
