How loose can monetary policy get?

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In-house macroeconomic view

Global outlook

The global economy is stabilising, with regional differences and greater uncertainty about the growth and inflation outlook. The hard data prints and the leading indicators for economic activity are currently sending contradictory signals.  The economic data that have been released for the U.S. are good, and only the outlooks point to slowing momentum. Interestingly, the exact opposite is true for Europe. That said, in our view, a soft landing of the global economy remains the most likely scenario. The disinflationary process is under way. However, services inflation remains stubborn, and there is still no sign of it returning to the central banks’ target any time soon. The initiation of monetary loosening, which will in all likelihood proceed very cautiously, and the expected pickup in growth could keep inflation above target. Rather than lessening the political uncertainty, elections in France, the United Kingdom and the U.S. (possibly even with a new Democratic candidate) are adding to the current challenges thanks to a potential increase in protectionism and further increases in budget deficits. While the conflicts in Ukraine and in the Gaza Strip are having few direct consequences for developments in stock markets, the lack of solutions is causing added uncertainty for investors.

U.S.

The U.S. economy grew almost 3% in real terms in the second quarter. With inflation at 3.3%, therefore, nominal growth is over 6%. This should come as no surprise given a budget deficit of 6.1% of GDP in 2023 and probably 6.7% in 2024. Despite this massive fiscal support, leading indicators are painting a mixed picture. They point to solid growth in the services sector and are sending contradictory signals for the manufacturing sector. Overall, we expect slower growth in the second half of the year. Industrial production and the manufacturing sector are showing signs of a recovery as companies continue to make long-term investments despite high borrowing costs and uncertain prospects. Both retail sales figures and spending in the services sector are down. Consumer confidence improved slightly in May but the downward trend remains intact due to the persistently high inflation, the record levels of household debt and the gradually cooling labour market. The number of job vacancies declined, and the number of people in employment again rose in May by a solid 272,000. Growth in wages again increased, to +4.1% year on year. The hope is that the rise in supply and the fall in demand for labour will put pressure on wages to fall in time. The latest inflation data, with a CPI of 3.3% and a PPI of 2.2%, indicate that price pressure is falling. The resumption of the trend in disinflation and the gradual easing in the labour market are good signs that the Fed’s patience was justified. The Fed will remain in wait-and-see mode, as inflation persists and will probably remain above target this year and next. We expect an interest-rate cut before the end of the year. Monetary loosening will proceed very slowly and data-based, if at all. “One and done” is the current mantra.

Eurozone

The eurozone economy is growing at a modest pace. However, developments in the key economies point to a gradual recovery. We expect that economic activity will gradually recover in the coming quarter on the back of lower borrowing costs. After a number of positive months, the business activity surveys are showing a certain slowdown in momentum in June due to political uncertainty. The purchasing managers’ indices (PMI) in the eurozone have fallen for both the manufacturing and the services sector. While the manufacturing sector remains in contractionary territory, services is expansionary despite a decline in the previous month. Consumer confidence is recovering from a low level, as inflation is falling and unemployment, at 6.4%, remains at an all-time low. The rise of populist political parties in several countries and the calling of an early general election in France mean political uncertainty that could have an impact on sentiment and economic activity in the coming months. Rising real wages are likely to shore up private demand in the coming months but could also ratchet up inflationary pressure again. The latest inflation figures (2.6% headline and 2.9% core) show that the disinflationary trend is intact but slowing. In particular, inflation in the services sector, having risen to 4.1%, is proving particularly stubborn and it, along with the increased growth in wages and the gradual pickup in overall demand, could keep inflationary pressure intact. After the ECB’s first interest-rate cut by 25 basis points in June, the trend should be clear, but the ECB, too, will proceed cautiously and very much data-based after raising its inflation outlook. We expect two further interest-rate cuts before the end of this year.

China

The patchy upturn in the Chinese economy continues. Having improved for two months, the business surveys have weakened again. The upturn in the manufacturing sector is slowing, as reflected in a decline in new orders. Industrial production and retail sales figures are expanding at a fair clip thanks to state stimulus measures. The services sector is growing but at a weaker pace. The government is still keeping a very close eye on the real estate market. Solving the problems in the real estate sector is key to boosting confidence and cranking up internal demand. For this reason, the government is prepared to provide further support if necessary. Not least because of this support and a recovery in global trade – as confirmed by corresponding data – we expect that the Chinese economy will continue to recover in the coming months. The biggest threat to recovery is escalating trade tensions. In addition, the deflationary pressure continues to give cause for concern. GDP growth of 5% for 2024 remains an ambitious target, which will definitely require additional political backing as well as no further escalation in protectionist measures.