Outlook on the economy
Inflationary pressures are clearly easing, but more expensive oil could throw a spanner in the works
With oil prices rising, for example, it is uncertain which way inflation will go in the months ahead. According to the Bloomberg consensus forecast, eurozone inflation will fall to 3.4% by the end of 2023 and remains above 2% until 2025. A similar pattern applies to the US with a slightly higher inflation expectation. Markets therefore think that inflation in both the eurozone and the US will not go to 2% for the time being.
Central banks likely to take a wait-and-see approach for now
For central banks, the main issue is how core inflation will now develop. This may be persistent under a positive wage-price spiral. Wages are still rising: collective bargained wages in the eurozone rose by 4.3% in the second quarter and real wages in Germany rose by just under 0.1% for the first time in July. However, there is no sign yet of a wage-price spiral, especially given the negative purchasing power development last year. Despite the fall in inflation, the risk of inflationary pressures remains, due for instance to another oil shock. Europe is more sensitive to this than the US. Europe is dependent on foreign energy suppliers, while the US is virtually self-sufficient. All in all, it seems that central banks will not change interest rates for the next three to six months unless there are significantly disappointing figures. In that case, further interest rate hikes will be back on the cards. Interest rate cuts are unlikely to come into play until a deep recession looms on the horizon.
Ailing Chinese economy is also impacting other countries in Asia and emerging markets
China's economy is struggling to recover after the harsh COVID-19 measures. As a result, financial markets are concerned about a possible hard landing in China. House prices are still falling and retail sales growth is weak. If the Chinese economy shrinks sharply, it is likely that the government will take stimulative measures. Yet a gradual easing seems more likely as the government seems to accept lower growth. The central bank cut interest rates only slightly and other stimulative measures were limited. Experts expect China's economy to grow by 5% this year, but only by 4.5% in 2024 and 2025. This is almost half the average of the past 20 years. If China does indeed have a hard landing, other Asian countries and emerging markets will be particularly affected. Countries such as Taiwan, South Korea, Thailand and Japan rely heavily on China as an export market and for tourism. China accounted for almost a third of tourism to these countries before the pandemic. Commodity exporters such as Chile and South Africa are also sensitive to a hard landing in China, as China is a major consumer of commodities such as steel, oil and copper. However, one positive aspect of a slowdown in China is that it is likely to cause deflation in the global economy. After all, China is one of the world's biggest buyers of commodities.
Financial markets, our view
We think equities will underperform in the period ahead because: 1. Monetary policy is still tightening (with the central bank raising interest rates to lower inflation). 2. There is less stimulus from the government to prop up consumption, while savings from the COVID-19 period are running out. 3. There is a lot of room for negative ‘events’ (e.g. wars, the growth slowdown in China and/or issues surrounding the US government shutdown). 4. There is still a real risk that inflation will remain high for longer than markets expect. From that perspective, the fall in share prices over the past quarter (less than -1% for developed markets) is still quite acceptable. Central banks are expected to keep their policy interest rates at the same level in the period ahead, although there is also a risk that policy interest rates could be raised a step or two further. The likelihood of interest rate cuts seem slim for now. All in all, we expect inflationary pressures to eventually ease further. Low inflation is good news for the economy and hence financial markets. Regardless of short-term fluctuations, we remain committed to achieving long-term pension goals.