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« Fluctuat nec mergitur »

Faced with high inflation and severe monetary tightening, advanced economies have shown unexpected resilience thanks to a range of shock absorbers, including savings, sound private balance sheets, lower sensitivity to the interest rate shock, a tight labour market and investment spurred by public policy. These economies are gearing down, each at their own speed – slowly but surely. And while they have yet to sink, the same holds for inflation.

In 2023, the US dodged a recession. In addition to surprisingly solid support from copious savings and the stimulus of President Joe Biden’s industrial policy, the key factor to this resilience was lower interest rate sensitivity. But the hit from monetary tightening is not painless, just slower to spread – and longer-lasting. With growth still positive, albeit below potential, it appears the economy will stay afloat until the middle of 2024 before the impact of rising interest rates makes a bigger dent through debt refinancing. So, our central scenario calls for a recession as 2024 flows into 2025, but a shallow one. This is because businesses – and above all households – are on solid financial ground. In addition, consumers should do well in a labour market where the ‘imbalance’ favours supply and any cooling would result in a slight rise in unemployment. They will also benefit from lower inflation, which should dip below 3% in Q224 – even if service prices stay higher. As such, our scenario includes a measurable decline in average growth in 2024 (1.2% after 2.4% in 2023), which will sink deeper (to just 0.5%) in 2025, despite acceleration in store at the end of the period due to lower interest rates.

In the Eurozone, until a few months or even weeks ago, many commentators were still predicting stagflation – but the recovery in domestic demand and deflation are fending off that threat. Admittedly, the slowdown is dramatic. But it will be buffered by the deflationary process, which leaves room for a soft landing on a downward growth trend. However, higher real interest rates, a structural competitiveness shock linked to energy and a deeply uncertain external environment are all setting the Eurozone economy on course for lower growth than its pandemic-weakened potential.

Some of the factors that have allowed European growth to dip without sinking – despite inflation that is abating but still high, and the acute impacts of monetary tightening – will still be at work in 2024. Above all, employment and wages are holding up at the expense of productivity and unit labour costs. So we are basing our very ‘soft’ growth scenario on a recovery in consumer spending. This in turn is justified by flatter but still positive job creation, sustained wage growth, continued (albeit slower) deflation and, ultimately, improved confidence indicating a reduction in precautionary savings. Dipping from 8.6% in January to 2.4% in November, average headline inflation (YoY) is expected to fall to 5.5% in 2023, then 2.8% in 2024 and 2.5% in 2025. Meanwhile, growth is expected to crest at 0.5% in 2023, 0.7% in 2024 and 1.4% in 2025. 

A year after China abandoned its zero-Covid policy, growth remains hobbled by structural issues, and stimulus policies are unable to generate the confidence necessary to stabilise and recover. The Chinese economy is operating below potential. It still suffers from a chronic lack of domestic demand, reflected by non-existent inflation. China is facing deflation and a serious real estate crisis, as well as an aging population, an accumulation of precautionary savings and high domestic debt. Taken together, it calls to mind late-1980s Japan and its “lost decade”. China’s 2024 growth target is expected to be officially announced in March and should be between 4.5% and 5.0%. It is more likely that the government will adopt a more cautious and conservative approach with a target of around 4.5%, to avoid the political risk of ‘missing the target’. Our 2024 forecast is around this level, at 4.4%. 


While the major central banks seem to have finished hiking their key rates, they are not done with inflation yet.

In terms of monetary policy, patience will be called for. While the major central banks seem to have finished hiking their key rates, they are not done with inflation yet. The quick and mechanical decline of headline inflation is likely to be followed by tougher – possibly stickier – core inflation. Our scenario for the US calls for lower headline and core inflation. Headline inflation is expected to stabilise at 2.4%, and core inflation at 2.7%, later in 2024 and throughout 2025. In the Eurozone, the risk of demand fuelling inflation has passed. But the wages-to-inflation transmission channel is still open, and the risk of second-round effects cannot be ruled out. Over the next two years, inflation is expected to stay above 2.4%. This means that inflation is slowly converging to the central banks’ ‘comfort zones’ (which are still unclear) but would still be higher than the 2% targets set by those policymakers.

These inflation forecasts call for a prudent monetary easing scenario. In terms of cutting key rates, the markets’ expectations seem ‘aggressive’. Our US scenario includes a 25bp drop – but not until July 2024. This reduction will be gradual, with another 25bp cut in November, putting the Fed Funds rate’s upper bound at 5% at the end of 2024. The predicted drop in growth could give the Fed room to accelerate its cuts in 2025. The upper bound is likely to be 3.50% at the end of 2025 – a threshold the Fed may struggle to move below, with inflation stuck above its target and a neutral interest rate that could top its previous mark. As for the ECB, its first rate cut (25bp) is expected in September 2024.  It would be followed by five cuts of 25bp each until the ECB reaches its neutral rate, with a deposit rate at 2.50%, in Q225.

Just as with monetary policy, our long-term interest rate scenario is one of ‘guarded optimism’. Between inflation, growth and the need to not ease financial conditions too quickly, everything urges policymakers to be patient and points to a scenario of moderate decline in long-term rates once the series of key rate cuts has begun. In the US, our scenario has Treasury yields declining when the Fed makes its first cuts. It also calls for a ten-year yield of about 4% by the end of 2024. In the Eurozone, our forecast for government bond yields ‘clears up’ in H224. Our scenario is of a cumulative reduction of 75bp in 2024 in the ECB’s key rates, starting in September. This should usher the fixed income markets into a phase of decline and moderate steepening. The Bund yield is expected to be around 2.60% at the end of 2024.

For more information, see our publication “World – Macro-economic Scenario 2024-2025: Fluctuat nec mergitur” dated on 23.12.22

​​​​​​* Fluctuat nec mergitur – The motto of the city of Paris: "[She] is tossed [by the waves] but does not sink".

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