14 Jun 2023
European inflation remains too high for central banks…
Labour market evolution will be key to the economic outlook in the coming months
The past month may have been dominated by US debt ceiling worries and discussions, but this has clouded some of the other ongoing changes in the macro data: notably some signs of slowing in mainland China and some more hawkish inflation data in Europe.
Inflation, particularly in Europe, remains far too high for central banks (Charts 1-2). The latest data in the UK have prompted us to now expect two additional 25bp rate rises from the Bank of England (BoE), while the stickiness in the eurozone means that the European Central Bank (ECB) will now likely keep tightening until September. With banking sector risks potentially subsiding and the economic data holding up in the US, the Federal Reserve (Fed) is still likely to lift the Fed Funds rate again.
This additional tightening will likely add to the downside risks later this year; however, for now, there is still some resilience in the service side of most macro data. PMIs look robust, employment is still growing, and consumer spending on services appears to be holding up. However, the manufacturing side of the data in most economies is faring much worse (Chart 3) – with manufacturing PMIs pointing to a contraction, goods spending looking weaker, and global trade data being held down as a result, with weak exports from much of Asia.
This trend is seen more clearly in mainland China than elsewhere – with the recovery so far this year being concentrated in the services side of the economy. Manufacturing data have fared much worse and are leading some to worry about whether the recovery has less legs to it than had been previously expected. The good news comes from India, where activity data remain strong, and with inflation coming down, rates look to have peaked.
The big challenge for policymakers is squaring these continued elevated CPI inflation prints with dropping price pressures throughout much of the economy. Input costs from a variety of sources have fallen sharply (Charts 4-5) – with energy prices, wholesale food prices and freight costs down a long way from the middle of last year. As stock gets replenished at a lower cost, could this put further downward pressure on goods prices? In the US, rental inflation will likely become a disinflationary force very soon – but this isn’t true elsewhere.
Offsetting this is the labour market. Wage growth remains robust in many economies and jobs markets are tight. However, things are cooling down: vacancies keep falling, workers are quitting less and wage growth may be slowing, at least in the US. How the labour market evolves will be key for the outlook in the coming months.
As a result, central bankers in much of the world still feel they have a bit more to do in terms of tightening. In others, rate cuts are being delayed. The impact that these higher rates will have on the economy remains uncertain, adding to the risks in the rest of 2023.
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