Asset Management Europe: Monthly Macro Insights - June 2023

Recent surveys have hinted at a slowdown in economic growth, but underlying inflation is proving more persistent, pressuring central banks to hike rates further. Yet, how tightening credit conditions interact with already restrictive monetary policy stances is a key uncertainty.

Mixed economic data

In early 2023, economic growth has been more resilient than feared. However, recent soft data seem to indicate a possible turnaround. In China, the manufacturing PMI unexpectedly fell to 48.8, the lowest reading since December 2022, and the non-manufacturing index (services and construction sectors) slid to 54.5 from 56.4, also below expectations. Investors have trimmed their 2023 growth forecasts to 5.5 per cent from almost 6 per cent earlier this year, but more downgrades might be needed.

In the US, the outlook is murky. On the one hand, surveys have deteriorated. The ISM manufacturing index fell to 46.9 in May, and in the services sector, business confidence fell to 50.3, a level seen lower only once since early 2010, barring the fall in 2020 in the midst of the pandemic. On the other hand, the labour market remains very tight.

Business confidence has also weakened in the Eurozone, especially in the industrial sector, and recent revisions showed that Germany fell into a technical recession earlier this year.

Tighter credit condition, falling demand

The ECB’s Bank Lending Survey (BLS) and the Fed’s Senior Loan Officer Survey (SLOS), published in early May, both showed financial institutions further tightened credit conditions, especially for businesses. The link between economic activity and credit is particularly scrutinised by central banks. Indeed, when credit grows, consumers can borrow and spend, and firms can borrow and invest. A rise of consumption and investments also creates jobs, which further spurs the economy. Conversely, higher costs and lower access to credit weigh on economic activity through negative effects on consumption and investment decisions.

That said, there is great uncertainty about the speed and intensity of these effects, especially since the share of fixed-rate loans in the economy is much higher than in the past monetary policy tightening cycles. In that regard, lags of monetary policy might be longer than usual.

The Fed’s Chair, Jerome Powell, has recently stressed that the credit crunch expected in the aftermath of recent bank failures, combined with the SLOS results, will likely weigh on economic growth and hiring. As a result, the policy rate may not need to rise as much as it would have otherwise to tackle inflation.

Meanwhile, ECB’s President, Christine Lagarde, acknowledged that the results of the latest BLS showed the impact of the tightening cycle, which convinced the Governing Council to downshift the pace of rate hikes, delivering a 25bps increase in interest rates instead of 75 or 50bps in prior meetings. That said, the ECB is likely to pursue its tightening campaign until it is sufficiently confident that inflation is on track to return to the 2 per cent target in a timely manner.

Completed writing on 7 June 2023.

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