Economic Outlook

ECONOMIC OUTLOOK

Central banks: rate cuts to be out-of-sync. Recent data confirms our outlook of positive growth with increasing regional disparities. The United States economy continues to beat expectations, intensifying debates about how fast inflation can fall. In the euro area and United Kingdom, indicators continue to show modest growth and gradually falling inflation. 2024 still looks to be the year of the pivot for key central banks but we now see the United States first rate cut later than Europe’s. Any worsening of geopolitics will likely widen this gap in policy further.

Activity remains resilient, particularly in the United States. The US economy continues to surprise on the upside, with demand still strong. This resilient performance is underpinned by a buoyant labour market, with an unemployment rate below 4% and 4% year-over-year wage growth. US growth should slow down in months to come, but only gradually, sustained by still accommodative fiscal policy and healthy private sector balance sheets. European economic data for Q1 also confirms the recent trend of barely positive growth but a stubbornly strong labour market. Looking ahead, the European economies should benefit from the easing of inflation followed by cuts to interest rates.

Rate cuts cycle to diverge. Inflation has been on the retreat all year in the major developed economies: down between December and March from 2.9% to 2.4% year-over-year in the euro area, 3.9% to 3.5% in the United States and 4.0% to 3.2% in the UK. However, the downtrend has come with some surprises, pointing in different directions either side of the Atlantic. Both the euro area and UK broadly surprised on the downside. In contrast, US inflation came down less than expected. This suggests central banks will no longer be cutting their rates in lockstep. Rather, the US may cut later and prove more gradual with its policy loosening. We still expect the ECB to cut rates for the first time in June and by a total of 75 bps by year end. The Fed is likely to start in Q3 and reduce rates by a total of 50 bp this year. Such a desynchronisation would boost the dollar and could prompt a spike in the euro price of oil, which has already been drifting upward.

Escalating tensions in the Middle East have helped foment the climate of doubt among policy-makers, particularly with major political events looming closer to home as well. The main risk from any fresh intensification of Middle Eastern tension would be a spike in the oil price. As a massive domestic producer, the United States would be able to mitigate such a risk. This could shield its domestic economic growth but could nonetheless spur resurgent inflation. In Europe, however, the danger is economic stagnation. Faced with different risks, the Fed and ECB might well diverge policy further.

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