Economic and financial risk insights: more progress on inflation, but policy trade-offs loom

• Global economic slowdown is ahead. We expect US growth to slow meaningfully and Europe's economic stagnation to continue in 2024.
• Meaningful progress on inflation, but too early for victory laps as labour markets remain historically tight.
• We expect the ECB to lead the way on interest rate cuts before the Fed. Central bank focus to increasingly shift from inflation to growth concerns.

The US economy has demonstrated more resilience than expected this year but even so, we expect growth to slow to below its potential rate, at just 1.1% in 2024. Higher interest rates are increasingly constraining household spending and corporate profit margins; US retail sales and personal consumption have continued to decelerate (see Figure 1), and muted manufacturing output (0.1% m-o-m in October, excluding sectors affected by strikes) points to stagnation.

Figure 1: US retail sales and personal consumption expenditure

The slowdown in Europe is more pronounced, where the transmission of monetary policy to the economy has been stronger and faster. Key economies in the region are close to, or already in, recession (see Figure 2) and we expect this to continue. With price pressures in the US and Europe still present, the monetary policy trade-off between lowering inflation sustainably to 2% and supporting growth will likely become more challenging in 2024.

Figure 2: GDP growth rate for selected European countries

The broader disinflation trend in the US remains on track despite an uptick in core inflation in November (see Figure 3). A similar reduction in price pressures is visible in Europe. While encouraging, measures of labour market tightness, including wage growth and job openings, suggest it is too early to declare victory on the inflation front.

Figure 3: US core inflation rate for different horizons

We expect inflation will be soft enough to support the start of an easing cycle in 2024 but see upside risks of inflation persistence given tight labour markets (see Figure 4). With current inflation trajectories for 2024, we expect the focus of central banks to increasingly shift from inflation to growth.

Figure 4: Measures of US labour market tightness

We maintain our position that both the European Central Bank (ECB) and Federal Reserve (Fed) are at the end of their rate hiking cycles, and see rate cuts starting in 2Q 2024. The ECB is expected to start cutting first, with risks for more and earlier cuts if inflation continues to slow faster than anticipated (see Figure 5).

Figure 5: Central banks' policy rates and market-implied rate trajectories

However, both the ECB and the Bank of England will, most likely, want to first observe wage negotiation results in early 2024 before cutting. Our outlook for the US – a gradual growth slowdown and inflation moderation – should allow the Fed to start the rate-cutting cycle in late 2Q. Markets are pricing in smooth rate adjustments but we note that historically, this has rarely happened.

A global economic slowdown in 2024 is still our baseline. Inflation progress has been meaningful but while labour markets remain tight, it is too early to consider disinflation complete. We expect central banks to engage in rate cuts next year to adjust for the inflation and economic growth outlook. 

Table 1: Key forecasts (in %)