Let the interest rate cuts begin

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In-house macroeconomic view

Global outlook

The global economy will grow more or less at the same pace as last year: approximately 3% to 3.5%. This means that a soft landing of the global economy remains the most likely scenario. However, the sketchiness and regional variability of the outlooks in the latest publications need to be highlighted. The U.S. economy is slowing down but remains healthy. The eurozone economy is over the worst and is showing signs of an upturn. The Asian economies are positive, with solid growth in India and gradual consolidation in the Chinese economy. Basically, we expect an upturn in the second half of the year with support from a stable labour market and ongoing fiscal packages.

Disinflation is proceeding, but at a much slower tempo than last year. Without doubt there is a risk that the envisaged upturn in economic activity will lead to further rises in commodities prices and higher wage demands, and inflation will therefore remain above the central banks’ target. Nevertheless, central banks in advanced economies will lower interest rates this year (starting with the ECB). Policy loosening will be incremental and cautious. Interest rates will remain higher than in earlier loosening cycles.

The biggest challenges for the global economy, in our view, are the large and growing national debt burdens and the geopolitical situation.

U.S.

Economic activity in the U.S. can still be classified as healthy. However, mixed and sometimes inconsistent data point to a slowdown. Despite the uncertainty that exists, we still regard a soft landing as the most likely scenario, not least because of the fiscal efforts of a president intent on re-election. With employment outside of agriculture having “only” increased by 175,000 and an uptick in the unemployment rate to 3.9%, there are clear signs of an easing in the labour market. Following three months of inflation exceeding expectations, the data for April were reassuring: the increase in both headline and core inflation for the month slowed to +0.3%. However, it must be noted that while inflation is gradually falling, it remains stubbornly high in the services sector in particular. There is a risk of price pressure rising further. Consumers are concerned about both, and the effects on spending are already apparent from the less marked rise in retail sales figures.

The resumption of the trend in disinflation and the gradual easing in the labour market are good signs that the Fed’s patience is paying off. The Fed remains confident that its policy is restrictive enough and will in time help inflation return to its target. It remains to be seen whether the first interest rate cut, which is likely to come before the year is out, will put an end to the environment recently characterised as “higher for longer” (H4L). There is no urgency on the U.S. central bank, at least on the inflation front. If anything, an interest rate cut could be justified on the grounds of the second part of the Fed’s mandate but the labour market is too stable for that. Unless this changes drastically, we expect one or two interest rate cuts at most, starting in September.

Eurozone

The European economy is over the worst; the period of stagnation is coming to an end, and the outlook is gradually brightening. The technical recession in the third and fourth quarters of 2023 is over. Real GDP growth in the first quarter was +0.3%. We expect economic activity to grow at a similar pace in the second quarter. The surveys on economic activity point to a positive growth dynamic. The global purchasing managers’ index rose in May for the third consecutive month, hitting the highest it’s been in a year. While the services sector continues to undergo solid expansion, the direction of the manufacturing trend is now also showing positive. These so-called “soft” data contrast with “hard” data that remain rather weak. Examples of this include industrial production and new orders, which still indicate weak domestic demand. Although the rate of unemployment, at 6.5%, is close to its historical low, consumer confidence remains in negative territory. In the first quarter, wages rose 4.7% year on year. This positive growth in wages, which is also real growth, is likely to shore up private demand in the coming months. Inflation is still coming down, but at a slower pace in recent times. The rises in May in both the consumer price index (to 2.6%) and core inflation (to 2.7%) show that the disinflation trend is not all one-way traffic. Services inflation in particular remains high. We expect consumer prices to return to the central banks’ target no earlier than 2025. That said, the ECB is confident that the trend in prices is on track and an interest rate cut in June therefore seems to be a done deal. Given the stubborn inflation data for services and high wage growth, it is hard to expect a lengthy loosening cycle soon.

China

The Chinese Politburo noted that the economy had secured a good start this year, but caveated that against “insufficient demand” and “an external environment that is... more uncertain”. Political leaders continue to pursue a proactive expansionary financial policy to achieve their GDP growth target for the year.
Monetary policy remains supportive. Policy tools such as interest rates and the reserve requirement ratio will be flexibly employed, and a stable exchange rate has high priority due to the uncertainty over U.S. monetary policy. The economic recovery remains uneven and real estate sector development uncertain. Various initiatives were launched in May to support the ailing real estate market: as well as removing the floor for mortgage rates and reducing the minimum down payment for homebuyers, the government began issuing ultra-long sovereign bonds. In addition, 300 billion yuan has been made available for local governments to purchase excess housing stocks from developers. The surveys on economic activity point to a moderate expansion. The manufacturing sector is growing while the services sector is weakening slightly. The tentative signs of an improvement in global demand are creating a buffer for the Chinese economy. The focus of economic policy is on strengthening domestic demand. Inflation data improved, with a rise in the headline CPI in April (+0.3% y/y) and a recovery in the core CPI (+0.7% y/y) after very weak growth in March. Producer prices remain in deflationary territory due to the ongoing weakness in the real estate sector (-2.5% y/y). The geopolitical situation remains tense and uncertain. The Biden administration has hiked up tariffs on several Chinese imports and Beijing has warned of possible retaliation in return.
A resumption of the trade war would not only threaten the still-fragile economic recovery in China, but also slow down the global economy.