Macroeconomic house view – October 2023

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Global outlook

Due to tight monetary policy and ongoing high inflation, global economic activity remains on a downturn. Geopolitical tensions and trade restrictions are impacting on international trade. The IMF has left its global growth forecast for 2023 unchanged, at 3%, and adjusted its forecast for 2024 downwards slightly to 2.9%. While the estimate for the U.S. was raised slightly, it was revised downwards for Europe and China. Corresponding leading indicators confirm this picture. Despite slight rises in unemployment rates, the labour markets remain tense in historical terms. Headline inflation is trending downwards but, given the weakening positive base effects, robust labour markets, rising real wages and ongoing fiscal supports, it will take some time to drop to the central banks’ target rate. Accordingly, key rates in developed economies remain at or close to their highs. However, as there are growing signs that the neutral rate of interest – i.e. the rate at which monetary policy is neither expansionary nor contractionary – will probably be higher than it was pre-pandemic, monetary policy will have to remain restrictive for a prolonged period of time.

The crux is that we only have estimates of what this level is; we can only say for definite with the benefit of hindsight. For that reason, interest rate cuts are not in sight at the moment. Should the restrictive monetary policy trigger a recession, however, interest rates could be cut very quickly. However, this is not our baseline scenario at present.

U.S.

The U.S. economy is continuing to prove amazingly robust. In the third quarter, the economy grew at an annualised rate of 4.9% compared with the previous quarter. The leading indicators improved slightly in October, both in the manufacturing sector and in the services sector, and are pointing to a moderate expansion in the coming months. The labour market is easing gradually and the balance between supply and demand is improving. It continues to prop up the robust consumer spending, as confirmed by rising retail sales. In view of the strong fiscal support, the healthy trend in incomes and solid labour market, there are no signs of recession. However, the U.S. economy is also facing a number of headwinds that could affect the coming quarters: restrictive financing conditions, high wage agreements in the automotive sector, the rise in oil prices, a possible government shutdown in November, and a rapidly growing budget deficit (up 23% to USD 1.7 trillion year on year), to mention but a few.

Considering this, it is no surprise that consumer confidence in October fell for the third consecutive month. The renewed tightening of financial conditions in October is helping the U.S. central bank to combat inflation. At the same time, the risks of overtightening have increased and must now be weighed up against the need for further interest rate hikes to tackle inflation. Given that inflation expectations have risen, the Fed must tread very carefully here. We expect a pause in the interest rate policy for the time being.

Eurozone

The economic data for the Eurozone remains disappointing and is well below estimates. The private sector is painting a bleak picture, indicating that the economy could be in recession. The business climate has deteriorated and the purchasing managers’ indices fell to a three-year low in October. Both the indicators for the manufacturing sector and for the services sector are slipping further into contractionary territory. Lending criteria were again tightened in the third quarter. The labour market is solid but weakening, as fewer new jobs are being created. Consumer confidence has stabilised at a very low level and household spending is down, ratcheting up the fall in retail sales. Weak demand from abroad and geopolitical tensions are affecting industrial production, and remain a problem for export-led economies like Germany and Italy. Price pressure has lessened markedly in October due to base effects but core inflation, at 4.2%, is still too high and headline inflation could increase again after energy prices rise.

In view of the rapid slowdown in growth and stubborn inflation, the ECB continues to be faced with the dilemma of aggressively combating inflation and thus risking a sharp economic slowdown or leaving it too long and risking harmful stagflation. We expect the ECB will assume a wait-and-see approach for the time being, similar to the Fed.

China

Chinese economic growth remains weak but showed signs of improvement in the third quarter. To support the economy and the real estate sector, which is still flagging, the National People's Congress decided to increase the budget deficit target from 3% to 3.8% of GDP. Regional governments have been asked to quickly complete the issue of special purpose bonds to finance infrastructure projects. The PBoC is also making plenty of liquidity available and has called on banks to lend to property developers. The targeted monetary and fiscal stimulus measures are starting to show results with a pick-up in GDP growth in the third quarter (+1.3% quarter on quarter). The consumer-driven recovery seems to be spreading, with an improvement in retail sales and industrial production in September. However, investment is still taking a hammering from the real estate sector. The leading indicators for future economic activity have returned to expansionary territory. Weak demand from abroad and trade tensions with the U.S. and Europe will, however, impact on Chinese growth for the foreseeable future. The risk of deflation remains real, as headline inflation in September was unchanged year on year, at 0%, and the producer price index is falling further (-2.5% year on year).