Horizon Q4│2023 - Economics

A divided economy

In large parts of the world, the wind is blowing in the manufacturing sector's face. Because consumers had to forgo services more than goods during the pandemic, they now have more pent-up demand for travel, dining out and other services than for goods. The result is an unusual gap between robust demand for services and pronounced weakness in manufacturing. In addition, many companies around the world had used the end of the pronounced supply chain bottlenecks in late 2022 and early 2023 to build up inventories of inputs and finished goods. Faced with weakening demand from the US, China and Europe, they are now reducing their inventories again. So, for the time being, they are producing less than they are selling.

Yet it often takes only two to three quarters for these companies to sufficiently clear their inventories. We expect the manufacturing sector to bottom out by the end of 2023 and a new upswing to start shortly thereafter.

Soft landing in the US

Despite the Fed's forceful reversal of interest rates, the US economy continues to hold up better than expected. Housing construction, which is particularly sensitive to interest rates, seems to be slowly stabilising after a 23% slump compared to the beginning of 2021. The labour market is losing more and more momentum. As a result, private consumer wage growth is also declining. But thanks to a sharp drop in inflation, consumers’ purchasing power, which is derived from their disposable incomes after deducting inflation, is rising. This supports private consumption.

Instead of a mini-recession at the turn of the year, we now expect a soft landing for the US, ie a phase of weak growth far below the trend rate of just under 2%, but no longer a decline in economic output. The global weakness in manufacturing affects the US less than Europe. From mid-2024, a less tight interest rate policy should strengthen the economic upward forces. In view of structurally high demand for housing, residential construction is also likely to pick up again from spring 2024. Fiscal policy is also contributing to the growth in demand. We therefore expect the US economy to reach an annualised growth rate of 2% again in mid-2024.

Mixed outlook for Europe

Two very different forces are shaping the outlook for the European economy in the coming months. On the one hand, the continent has weathered the Putin shock well. With inflation on the decline, a stable labour market and higher wage increases consumer incomes have been rising more strongly than prices since the second quarter. In real terms – ie after deducting inflation – consumers have more money in their pockets again. This has already been reflected in lively travel activity in the summer. On the other hand, the manufacturing sector is in recession. The weak world demand for goods as well as the inventory correction is hitting countries that specialise in exporting goods, like Germany, particularly hard. After stagnating in the summer, economic output in the eurozone is expected to decline somewhat in the final quarter.

Nevertheless, there are signs of a new upswing in the coming year. We expect the inventory correction in the manufacturing sector to come to an end by the end of 2023. Many companies are currently holding back on investments in view of the great uncertainties. As soon as the economy regains some momentum, they will spend more next year to restructure supply chains and replace scarce labour. Although China will remain structurally weak, exports to China are likely to pick up slightly next year. Finally, China should grow at around 3-4% in 2024. Then, by mid-2024 at the latest, with the US economy returning to normal growth, the economy in Europe could also regain the momentum of the period before the Russian attack on Ukraine began. For the UK, we expect a similar course as for the eurozone.

Inflation continues to decline

Price pressures continue to ease on both sides of the Atlantic, faster in the US than in Europe. As the US labour market continues to lose momentum, wage pressures there are slowly decreasing. By contrast, wages in the eurozone are likely to rise by at least 5% in 2023, before wage growth then falls back to around 4% in the course of 2024. In the US and Europe, inflation rates will tend to fall further. The somewhat higher oil prices interrupt this only briefly. The peak of food price inflation has passed. As transport costs have fallen, price pressures in this area will also ease with weak demand for goods. However, higher wage growth in Europe will continue to push up prices for wage-intensive services, so that inflation in Europe is likely to settle at around 2.5% from Q4 2024 instead of the around 1.5% in the years before the pandemic. For the US, we also expect inflation rates close to 2.5% for 2024 and 2025.

Central banks – interest rate peak (almost) reached

The less robust labour market in the US and the weaker economy will presumably prevent the US Fed and the ECB from further (noticeably) raising their already high key interest rates. As soon as the phase of economic weakness has sufficiently dampened inflationary pressure, the Fed will then lower interest rates again somewhat
from spring 2024, while the ECB will probably not ease its interest rate policy in the coming year in view of inflation remaining above 2%.