Asset Management Europe: Monthly Macro Insights – May 2023

While tracking a firmer pace than feared in Q1-23 GDP, incoming reports suggest much of the strength can be attributed to China. Meanwhile, central banks have continued their tightening campaign amid stubbornly firm wage growth and sticky core inflation. Will they continue until something breaks?

Unevenly distributed growth momentum…

China’s GDP expanded 2.2 per cent q/q in Q1-23 following 0.6 per cent in Q4-22, supported mainly by the strong rebound in households’ consumption as the authorities abandoned their zero-Covid policy. Looking ahead, spending on services is set to remain strong, although uncertainty remains elevated on other categories as recent indicators have provided conflicting signals about the recovery.

In the US, economic growth disappointed as GDP expanded a mere 0.3 per cent q/q (or 1.1 per cent annualized), less than half the prior quarter’s pace and below consensus expectations. That said, as it is often the case, the details are difficult to untangle.

According to the flash estimate, Eurozone GDP was up a mere 0.1 per cent q/q last quarter, after a -0.1 per cent contraction in Q4-22. Investors remain optimistic regarding the outlook as the S&P Global business confidence index improved once again in April to a 11-month high despite the recent banking stress, although the upturn was very unevenly distributed.

… while inflation pressures remain elevated

Global headline inflation has been declining since mid-2022 amid a fall in commodity prices, especially energy. To dampen demand and reduce underlying inflation, most central banks around the world have been raising interest rates since 2021, both at a faster pace and in a more synchronous manner than in the previous global monetary tightening episode just before the global financial crisis. However, core inflation remains much stickier than projected.

Indeed, although the transmission of monetary policy is generally thought to have long and variable lags, there are several factors that have contributed to more persistent underlying price pressures. The boosting impact of the Chinese reopening, combined with a warmer winter that supported the construction sector and prevented an energy crisis in Europe, have frustrated central banks’ efforts to slow down the economy. What’s more, several governments acted swiftly to extend support to households and firms, which helped cushion the effects on growth.

Meanwhile, labour markets remain tight in most countries. In that context, cost pressures from wages not only remain elevated in most advanced economies, but some measures are showing signs of a re-acceleration.

Accordingly, central banks are forced to stay firm in their communications about the need for a restrictive monetary policy stance, signalling that interest rates will stay higher for longer than previously expected to address sticky inflation. Yet, as we have argued last month, there are few reasons to think that monetary policy has become inoperative, and although the lags might have lengthened, some investors might end up being caught off guard when the full impact will start to bite.

Completed writing on 4 May 2023.

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