Growth Outlook: Poor

WEAKER GROWTH OUTLOOK

Growing signs of global economic slowdown have paradoxically led to a recovery in risk sentiment this week. Markets are forward-looking and sense that evidence of a loss of economic momentum brings with it more clarity on a peak in inflation and, eventually, interest rates. Global PMI surveys have reinforced expectations of softening activity and are also pointing to some cooling of inflationary pressures, raising hopes that central banks may not have to tighten policy as aggressively as previously feared. US policy rates are set to rise significantly further this year, but markets are currently pricing in rate cuts from around the middle of next year. For the UK, markets see at least 175bp of hikes by early next year, significantly more hawkish than the consensus of economists’ forecasts, but anticipate rates peaking thereafter. The economic outlook, however, remains highly uncertain and financial market volatility is likely to persist. A near-term peak in inflation is one thing, but whether it falls quickly enough to stave off restrictive monetary policy is another. US Fed Chair Powell this week acknowledged that a soft landing for the economy is ‘very challenging’ and that a recession is ‘certainly a possibility’.

SURVEY HINTS AT INFLATION PEAK

The PMI survey was particularly weak for the Eurozone, with the composite index dropping to 51.9 in June, the weakest since early 2021, reflecting contraction in manufacturing and fading pent-up demand for services. In the UK, the composite PMI held steady at 53.1, but is significantly lower than in the first four months of the year, while consumer confidence on the GfK measure fell to a new all-time low of -41. The PMI surveys point to a moderation in the underlying pace of growth in Q2 for both the Eurozone and the UK. More concerning is that the future output indices point to further losses of momentum in the coming twelve months. The surveys’ price indices signalled a softening of inflationary pressures, particularly for the Eurozone, but they remain at very high levels from a historical perspective. Latest data showed UK CPI inflation data increasing to 9.1% in May and the Bank of England expects it to rise above 11% later this year.

EURO FOCUS ON CPI AND ECB SINTRA FORUM

A key focus for financial markets in the week ahead is the ECB’s forum held in Sintra (Portugal) entitled ‘Challenges for monetary policy in a rapidly changing world’. Inflation continues to be driven predominantly by energy and other imported goods, exacerbated by the war in Ukraine. That will maintain focus on geopolitics, with G7 and NATO summits taking place in the coming days. However, signs that inflation is broadening out towards services will draw attention on discussions in a policy panel at Sintra on Wednesday consisting of ECB President Lagarde, Fed Chair Powell and BoE Governor Bailey. The key European data release will be the preliminary ‘flash’ estimate for Eurozone June CPI inflation (Fri), preceded by national releases from Germany, France and Spain. We forecast Eurozone annual headline CPI to increase to a new high of 8.5, up from 8.1% in May, driven by further rises in food and energy as well as an uptick in core inflation to 3.9% from 3.8%. Such an outturn would reaffirm the ECB’s signal that it will raise interest rates by 25bp in July and increase the likelihood of a larger 50bp increase in September. We also expect Eurozone unemployment to fall to 6.7%, adding to indications that the labour market may be starting to tighten. The Eurozone economic sentiment index (Wed), however, is expected to fall, led by lower consumer and industrial confidence.

KEY US AND UK DATA UPDATES

In the UK, the update for Q1 GDP (Thu) is expected to reaffirm 0.8%q/q growth. Given cost-of-living challenges for households, there will be attention on the disposable income and savings data, and what they may portend for consumption going forward. BoE money and credit data (Fri), including mortgage approvals, and Nationwide house prices (Thu) will also be released. House prices are up by more than 10%, according to last month’s Nationwide data. The latest RICS survey, on the other hand, points to moderation in new buyer enquiries. The Lloyds Business Barometer (Thu) will also provide a more forward-looking gauge on businesses’ trading prospects, their assessment of the wider economy and their expectations for hiring, prices and wage growth. An updated estimate for US Q1 GDP (Wed) is expected to confirm quarterly annualised contraction of 1.5%, dragged lower by inventories and net trade. The underlying picture was not as negative and supports expectations of a return to growth in Q2. Nevertheless, headwinds to growth appear to be building. Initial jobless claims have edged higher, providing signs that the labour market may be starting to soften, while business and consumer confidence has fallen. Next week’s data for durable goods orders (Mon), the goods trade balance (Tue) and construction spending (Fri) will provide further information on how the economy is progressing. Further, we expect declines in the Conference Board’s measure of consumer confidence (Tue) and the ISM manufacturing survey (Fri). Meanwhile, the Fed’s preferred inflation gauge, the personal consumption expenditure (PCE) deflator (Thu), is expected to mirror the movements in the already released CPI. We expect the headline PCE deflator to rise to 6.5% from 6.3%, while the core PCE deflator is forecast to edge down to 4.8% from 4.9%. As elsewhere, inflation is expected to remain above target for a considerable period ahead.

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