Significant headwinds from tighter monetary and fiscal policy are starting to slow growth in the eurozone. However, the labour market and services sector remain resilient.
Eurozone: weak growth, strong job market
Data published this week by Eurostat showed that the eurozone economy hardly grew at the start of 2023. GDP was up by 0.1% quarter-on-quarter (QoQ), only marginally better than the 0% growth in the fourth quarter of 2022. National-level data point to private consumption as the main culprit thanks to real purchasing power losses. Net exports contributed positively to GDP growth, supported by strong exports of services (tourism).
In contrast to the GDP weakness, signals from the labour market are stronger. Eurozone employment was up by 0.6% QoQ, outperforming GDP, but pointing to weakness in labour productivity. The dynamic labour market will maintain wage pressures but should also support private consumption.
Our macroeconomic research team expect a mild rebound in eurozone growth during the first half of 2023, reflecting improved sentiment on the outlook for energy prices. The risk is of a policy-induced tightening in financial conditions leading to a significant softening in economic activity, and perhaps to an outright recession
Services now driving eurozone core inflation
The final April eurozone Harmonised Index of Consumer Prices (HICP) release confirmed inflation edged up in April to 7.0% year-on-year (YoY) due to energy base effects. A fall in food prices helped to offset the impact of higher energy prices.
Core inflation edged down relative to March to 5.6% YoY, but on a monthly basis inflation rose, with services driving the increase. This data confirms the rotation from goods to services as the main driver of core eurozone core inflation.
Our macroeconomic research team expect core inflation to stay sticky around current levels at least until the end of the summer. Headline inflation however has room to decline further.
Germany: Fall in investor confidence
The ZEW survey, a good leading indicator for turning points in the economic trajectory, showed a sharp deterioration in German investor confidence in May. The ZEW ‘Expectations’ survey for Germany plunged from back into negative territory for the first time since December 2022. The current assessment indicator was relatively stable.
The fall in ‘Expectations’ for the US was smaller, but it is at a low level. In China the net figure remains positive. Sector profit expectations bifurcated further, with investors becoming more pessimistic on car manufacturing, steel and chemicals, but more optimistic on domestic-oriented utilities, services and finance.
This third decline in the ZEW Expectations survey along with the drop into net negative territory may herald declines in the Purchasing Manager Indices and the German ifo survey next week, signalling downside risks to eurozone growth.
US debt ceiling talks inch forward
President Biden cut short an overseas trip and returned to Washington on Sunday, after hints that lawmakers were moving towards a deal to raise the debt ceiling and avert an unprecedented government default. There is now little time left to reach a comprehensive deal before Treasury Secretary Yellen’s estimated date when the Treasury will run out of money (as soon as 1 June).
President Biden and congressional leaders may only agree to a short-term deal, requiring a more substantive accord to be reaching in the autumn.
US policy rates on hold
In line with our expectation that US policy rates are now on hold before a possible first rate cut in December, Chicago Fed President Goolsbee and Atlanta Fed President Bostic each hinted toward a preference for a pause at the meeting of the Federal Open Markets Committee on 13/14 June. Goolsbee advocated “prudence and patience” in assessing stress in the banking sector.
Strategies anticipating a bull steepening of the US yield curve (short-term interest rates falling by more than long-term rates) offer insurance against a possible hard landing of the US economy. This strategy, however, is costly from a carry perspective due to the amount of interest rate cuts the market has already priced in.
The US banking turmoil triggered a steepening of the US yield curve in March (see Exhibit 1 below). Should there be no further ructions in the US banking sector and a sustained Fed-on-old period, it could prove challenging to steepening positions. We maintain this position as a hedge against a worsening in the outlook for the US economy.