China’s re-opening bolsters our base case scenario of a relatively soft landing. The start of the year brought relief for some of the risks overshadowing the world's economy. First, the rapid ending of Covid lockdowns in China should prompt a rebound in domestic demand which will also be good news for its trading partners. Elsewhere, the easing of pressures on Europe’s energy markets helps alleviate some of the continent's problems. These pieces of good news confirm our belief that the economy is headed for a relatively soft landing, with recessionary environments not unlikely but playing out comparatively mild by historical standards. While above-average inflation continues to weaken household purchasing power and tighter interest rates discourage corporate investment, households are still sitting on substantial, albeit falling, Covid savings and labour markets continue to be strong.
In the United States, growth remained solid in the last quarter of 2022, at +2.9% year-on-year. Leading indicators for the start of 2023 suggest an ongoing deterioration of activity in some sectors, particularly industrial production and real estate. While persistently high inflation continues to weaken households’ purchasing power, a robust labour market is helping mitigate the hit to real incomes. At the same time, reasonable surplus savings built up during Covid are likely to provide a supportive cushion for consumer spending for now.
The UK’s local economy will continue to face challenges amidst the unfolding cost of living crisis and a relatively tighter fiscal policy: conditions are exacerbated an unusually high exposure to whole-sale gas prices due to lack of storage, a high proportion of fixed-rate mortgages coming due, and a relatively inelastic supply of labour. However, relative calm has returned to its political environment and the FTSE 100’s favourable sectoral composition should benefit from China’s reopening.
In Europe, an easing of energy prices and the reopening of China’s economy reduces the chance of the kind of deep recession many feared when the war in the Ukraine broke out. Latest indicators also suggest a slight revival in Eurozone activity. Economies will continue to draw strength from solid labour markets and still significant Covid savings as well as the direct support from government fiscal policies.
China should enjoy a significant bounce in its domestic economy thanks to the cliff-edge ending of anti-Covid measures. Household consumption – having run well below its long-term trend for the last three years – should rebound as Chinese households have their own backlog of Covid savings and should be able to afford a spending spree.
Inflation will continue its rapid decline particularly in the US, but central banks will remain on alert. The easing of commodity prices, particularly with regards to energy, should bring a rapid fall in headline inflation for developed economies over the coming months. However, the ripples of the price shock that hit a year ago will continue to spread, notably through wages, keeping core inflation elevated. As a result, central banks will continue to tighten policy in the short term before calling a halt. They are likely to stick to their hawkish tone until sure that underlying inflation can be brought back to near target – their credibility is on the line.
In accordance with the regulations in force, we inform the reader that this document is qualified as a promotional document. Unless specified, all figures and statistics in this report are from Bloomberg and Macrobond on 27/01/2023, publication completion date.
