Jérôme Haegeli, Group Chief Economist
“A slower and more cautious phase of the central bank policy rate hiking cycle has begun amid inflation peaking, financial stability concerns and inflationary recessions on the horizon. Still, the overall direction remains higher,with central banks needing to do more to overcome inflationary pressures.”Jérôme Haegeli, Group Chief Economist
Central banks are starting to tread more carefully on interest rate rises
The string of 50 basis point (bp) hikes by the Federal Reserve, ECB, SNB and BoE this month suggests a new phase in the hiking cycle has begun.
We expect central banks to continue hiking, but in smaller increments,acknowledging financial stability risks stemming from the unprecedented tightening earlier in 2022 and interest rates passing above neutral.
We still view talk of central banks cutting rates in 2023 as premature, with y-o-y headline inflation rates at around peak levels. We expect CPI inflation in major economies to remain on average above central bank targets into 2024, and nudge up our euro area forecast to 3.2% (+0.2 ppt).
We reduce our 10-year US government bond yield forecasts by 20 bp for 2023 and 2024 after yields declined from recent highs.
US and euro area economic strength adds upside risk to interest rate forecasts. We continue to anticipate inflationary recessions in the next 12-18 months, but recent data adds nuance to the outlook. Euro area “hard” economic data such as third quarter GDP prints defy the pessimism seen in “soft” survey data like PMIs ) and consumer confidence.
With the chance of forced energy rationing this winter falling considerably and generous fiscal support, we now expect a milder euro area recession this winter than previously feared and thus see upside risk to our 2023 growth and ECB rate forecasts.
The US labour market, though softening, is still tight, adding 263 000 jobs in November amid elevated wage growth.
We shift our US recession call out further in 2023 and lower our2024 GDP growth forecast on the lagged impact of monetary policy and a sluggish economic recovery.
The pivot in China’s zero-COVID policy is starting earlier than expected.
The unwinding of COVID restrictions implies a boost to China’s consumption next year. Yet we first expect an adverse shock to consumption due to self-isolation soon after relaxing COVID measures. With economic growth the central government’s top priority for next year, we raise our 2023 real GDP growth forecast to 4.5% (+0.4 ppt).
While a release of demand from China poses upside risks to global growth, China’s reopening may put further strain on fragile energy markets, adding upside to global inflation risk.
“A slower and more cautious phase of the central bank policy rate hiking cycle has begun amid inflation peaking,financial stability concerns and inflationary recessions on the horizon. Still, the overall direction remains higher, with central banks needing to do more to overcome inflationary pressures.” said Jérôme Haegeli, Group Chief Economist, Swiss Re
Baseline view changes
We raise our 2023 GDP forecast in China, and nudge down CPI inflation. We lower our 2024 GDP forecasts for the US and Switzerland, and add 25 bp to our BoE policy rate forecast in 2023. We adjust euro area inflation 0.2 ppt higher in 2024.
We reduce our 10-yr US government bond yield forecasts by 20 bp for 2023 and 2024
Geopolitical and social risks
Uncertainty generated by the war in Ukraine and related ramifications such as the cut-off of natural gas from Nordstream 1 will cause significant economic pain across Europe.
China’s ongoing trade restrictions and sanctions on Taiwan could further disrupt regional supply chain stability, adding upside risk to the inflation outlook for certain industries.
Key to watch: Russia-West tensions, economic sanctions, gas flows to Europe, US-China strategic competition, China-Taiwan relations
Stagflation risks
Inflation has become more entrenched in many major markets even though interest rates have been rising at the fastest pace in decades. With unemployment also close to record lows and wage growth having lagged the increase in costs of living, more collective wage bargaining and/or strikes may result.
The tension between higher government spending (relief for poorest households) and central bank tightening (to fight inflation) raises the prospect of fiscal dominance and structural stagflation.
Key to watch: more persistent inflation categories (eg, rents), euro area energy crisis,wages, labour shortages and strikes, unfunded fiscal plans
Energy crisis
The energy crisis in Europe could dampen industrial production, lead to a loss in competitiveness, reduce consumer spending amid a cost-of-living crisis and add more persistent inflation pressures.
Industries reliant on cheap Russian gas may have to adapt. Unstable fuel supplies also expose the shortcomings of renewable energy provision as a backstop in the short term.
Key to watch: spot and futures market energy prices, OPEC+ announcements, trade sanctions, monthly inventories, weather, new supply contracts
Aggressive policy tightening
Concerns that high inflation expectations become entrenched, of second-round effects (eg, wage-price spirals) and of rapid depreciation against the USD because of rate diferentials vs an aggressive Fed, are all factors that could lead central banks to effect more (than anticipated) monetary tightening, compounding the economic downturn.
Key to watch: central bank speeches, inflation expectations, fiscal announcements,capital flows out of/into emerging markets
Rise in business insolvencies
As inflationary recessions play out, the risk of business insolvencies is rising. The expected growth weakness in this cycle may not prevent central banks from sharply increasing interest rates and keeping them relatively high for longer, even in recession.
This would increase borrowing costs for already under-pressure businesses.
Key to watch: business insolvencies, credit spreads, restructuring/default rate news,debt servicing costs (interest rates)
Stronger global growth
The shift away from ultra-accommodative policy could lead to a stronger role for the private sector and investment shifts away from “intangible” assets towards the real economy.
The beginning of the unwind of China’s zero-COVID strategy is key to watch,with positive spillovers for global growth. Higher fiscal spending related to the war in Ukraine (eg, in defence, renewable energy and protecting consumers from the cost-ofliving crisis) could boost growth; resolution of the conflict would also present economic upside. Faster productivity improvements from technological innovation would benefit longer term growth.
Key to watch: fiscal spending plans, easing of China’s zero-COVID strategy, PMIs,consumption, real interest rates, productivity
Key takeaways
• We expect central banks to continue hiking interest rates, but at a slower pace as monetary policy enters restrictive territory.
• We see central banks keeping interest rates above neutral in 2024 as inflation gradually falls towards target levels.
• We now expect the euro area to enter a milder recession this winter than originally expected, while the US recession is pushed further back in 2023. We also expect lower 10-year yields in the US in 2023 and 2024.
• Faster than anticipated loosening of zero-COVID policy in China leads us to revise higher our 2023 GDP forecast, with 2024 nudged lower due to base effects