European and US Economic Outlooks and Comparison

Central Bank

Summary:

From the second half of 2024, the economic growth gap between the US and Europe will gradually narrow. Europe's economic growth is expected to accelerate, thanks to the recovery of consumer confidence and external demand. In the US, the reduction in fiscal policy support will further weigh on economic growth.

Future global economic growth will be slower than expected. The global economic growth rate is expected to reach 2.7% in 2024-2025, following the rate of 2.8% in 2023. Growth in advanced economies is expected to be steady at 1.6%, while growth in emerging countries will slow to 4% (down 0.3% from the previous reading).

Geopolitical uncertainty remains elevated. The global economy is developing as a more decentralized and multipolar world. It is undergoing major transformations. Old economic models are challenged due to their unsustainability, while viable alternative models are still developing, leading to growing divergence and uncertainty.

Against this backdrop of political and economic turmoil, 2024 will be a pivotal year as major elections will be held around the world, including in the US, India, Mexico, the European Union, South Africa, and the United Kingdom. These elections will create a high degree of uncertainty not only at the national level but also in the broader political and economic sphere, which could exacerbate social tensions.

Ongoing instability poses several risks, including the spillover of new and existing conflicts, increased migration pressures, and the risk of trade and supply chain disruptions. The tone of the 2024 US presidential campaign and its outcome will be a material risk to the unity and unanimity of Western countries on foreign policy issues. A further deterioration in US-China relations could exacerbate geopolitical downside risks, especially given fragile supply chains, changing trade dynamics, and resurgent industrial policies.

Inflation Rebounding

Sticky service price inflation has hampered progress in disinflation.

The resumption of supply chain disruptions and the decline in commodity prices drove down commodity and food inflation in 2023. This trend is expected to continue, with oil prices averaging 83d/b in 2024 (unchanged from 2023) and 81d/b in 2025.

The decline of headline inflation in the Eurozone has been more pronounced than in the US: CPI inflation in the US has remained above 3% since June 2023, while the Eurozone fell below this threshold in October 2023. This suggests that domestic demand in the US is stronger than in Europe.

Services inflation (excluding housing), which is most sensitive to domestic conditions (rather than commodity prices and supply chain constraints), has picked up in the US since the fall of 2023 and eased in the Eurozone. However, core inflation in the Eurozone has also picked up pace over the past few months as service prices have risen. This partly reflects the impact of the rapid growth of labor costs: wage growth, albeit slow, remains high. Productivity growth remains bleak. In addition, supply-side deficiencies continue to put upward pressure on service price inflation.

European and US Economic Outlooks and Comparison_1

Continued easing in the labor market is expected to bring inflation down in the summer.

Against this backdrop, the US labor market remains generally accommodative. The voluntary quit rate, one of the indicators of tightness in the US labor market, has fallen significantly, signaling a further decline in wages this year. In addition, the latest data shows that GDP growth has been slowing since the beginning of the year, which will also ease inflationary pressures in the coming quarters.

The Eurozone labor market also continues to ease, with fewer companies reporting the impact of labor shortages on production. The job vacancy rate, a measure of the imbalance between supply and demand in the labor market, continues to decline. However, Italy and the UK have recently stalled due to declining labor supply growth.

The Corporate Output and Input Price Survey, a reliable measure of inflation over a period of 4 to 6 months, generally points to persistently low core inflation in the US and European countries, including service prices. Headline inflation in the Eurozone and the UK is expected to hover below 2.5% over the summer. US CPI inflation is expected to fall below 3% in May-June. PCE inflation, the Fed's target for measuring inflation, will hover around 2.3%.

Timing of Rate Cuts

The Fed is expected to adjust interest rates in July and cut rates by 100 bps amid improving inflation and a more dovish FOMC stance.

As FOMC members said, they will not wait until inflation falls to 2% before cutting interest rates. The Fed's interest rate outlook remains largely dependent on the trajectory of inflation. In the latest Summary of Economic Projections (SEP), the Committee raised its forecasts for GDP growth and core PCE inflation at the end of 2024.

However, it is worth noting that they have not changed the outlook for interest rates, which are still expected to be cut by 75 bps by the end of the year. This means that Powell and the vast majority of FOMC members strongly believe that rate cuts should not be postponed for too long. It's easy to see that the FOMC has become more dovish: it expects stronger economic growth and a slight rise in inflation but doesn't want to delay or reduce rate cuts.

US inflation is expected to move faster towards the 2% target in May and June than the FOMC forecasts. We think it will be enough to convince committee members to pivot in July.

In addition, economic growth is likely to be slower than expected by the FOMC by the end of the year, which may also provide a case for Fed policymakers to cut rates slightly more than the SEP suggests. In summary, the Fed is expected to cut rates by 25 bps in each of its remaining four meetings this year (July, September, November, and December).

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The ECB will be forced to cut rates ahead of the Fed due to a different economic backdrop of lower inflation and stagnant output.

The ECB is also expected to start a rate cut cycle in July, but nine working days earlier than the Fed. The ECB will respond to improving inflation and economic stagnation that has lasted for a year and a half.

The ECB's historical order of following the Fed is more about correlation than causality, highlighting the likelihood that the ECB will lead this cycle. Several ECB presidents have also recently highlighted this point. In past events such as the global financial crisis and the dot-com bubble, the initial economic problems in the US have justified the Fed's priority in adjusting interest rates. On the contrary, during the Eurozone crisis, the ECB aggressively lowered interest rates, while the Fed stood still. Today, the current economic polarization has intensified again. Inflation in the Eurozone is 2.6% and falling, while inflation in the US is stagnant at 3.1%. Moreover, the stark contrasting growth trajectory further underscores the urgency of the ECB to act amid the growing risk of overtightening the economy.

According to a simple Taylor rule analysis, the ECB is at risk of "falling behind the curve" again, albeit in the opposite direction from 2022. Moreover, the gap between the current real policy rate and the neutral rate, a measure of policy restrictiveness, is also unprecedented. With inflation expected to fall at the same time, the gap is expected to persist even if real interest rates are lowered. As a result, the Fed may be able to delay further rate cuts, but the ECB cannot.

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However, before the action of the Fed, an early rate cut by the ECB could put downward pressure on the euro exchange rate, raising imported inflation.

For now, the main driver of inflation remains domestic wage-driven services inflation. As a result, the impact of the euro's depreciation on inflation is generally considered to be insignificant. On the contrary, the weakness of the euro will give a positive boost to the struggling European economy. Looking ahead, after the ECB cut rates in July and September if the economic recovery is strong in the second half of the year and inflation still does not reach its 2% target, then the ECB may pause again in October and December before continuing to cut rates in 2025. This will also reduce the pressure on the European currency to depreciate.

US Economic Growth Is Strong, but Likely to Slow Slightly

GDP is now expected to grow by 2.4% this year, higher than the Fed's SEP projections.

The first reason is that the US economy ended 2023 much stronger than expected. GDP grew by 3.1% YoY in the fourth quarter of 2023.

The second reason is that there will not be zero growth in the second and third quarters of 2024, as the strong economy in 2023 was supported by public spending and consumer spending. Public spending accounted for a quarter of US economic growth last year, with local governments accounting for more than two-thirds of total public spending growth. In addition, consumers spent more than expected, driven by excess savings during the pandemic. US households drew nearly $2 billion in pandemic savings in the third quarter of 2023 (not on an annualized basis) and $220 billion in the fourth quarter of 2023. The acceleration in the US stock market and housing prices could prompt US households to save less and spend more.

Finally, the influx of immigrants last year has boosted the size of the workforce and potential GDP growth. According to research by the Congressional Budget Office, the total number of immigrants reached 3.5 million in 2023, which was 2.5 million more than the trend. This was well above the level of 1.6 million suggested by changes in the foreign-born population in household surveys.

US economic growth momentum will slow down during the year but remain strong. Upcoming data for the first quarter of 2024 suggests that the continuous growth in the US has passed its peak and is slowly cooling down. Growth is expected to reach around 2% in the first quarter of 2024 (3.2% in the fourth quarter of 2023).

Looking ahead, growth momentum will continue to slow. First, fiscal support is starting to wane. While state and local governments still have significant cash buffers, budget plans, and lower revenues suggest that the spending frenzy is over. The agreement signed last year with congressional Republicans to limit federal spending growth has begun to limit the government's fiscal impulsiveness. The government's overall fiscal impulse is expected to turn moderate this year.

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At the corporate level, investment growth is expected to slow, and policy-induced spending on manufacturing factories is now fading.

Overall, the last quarter's financial report shows that companies are prioritizing cost-reduction measures in an environment where financing costs have remained high for a long time, leading to an increase in the number of bankruptcies. Against this backdrop, consumption growth is expected to heat up and cool this year, supported by a favorable wealth effect and strong migration.

In summary, zero GDP growth is not expected in the second and third quarters of this year but a gradual slowdown to 1.3% is possible between the end of 2024 and the beginning of 2025.

However, uncertainty remains high in this presidential election year.

The presidential and congressional elections in November could have a significant impact on the outlook for the US economy in 2025, particularly on the design of fiscal and trade policies, and the timing of their implementation.

In particular, changes in spending and tax policy are decided by Congress, and the Senate needs a majority of members to "filibuster" to push through legislative reforms. As a result, whoever wins the White House will be constrained in enacting substantive legislative reforms. For example, even if Biden were re-elected, Biden's flagship proposal to significantly increase taxes on the wealthy and corporations might never pass, given that Democrats are relatively unlikely to win both houses of Congress. Moreover, if Trump is elected, will he negotiate with his trading partners first and raise tariffs all at once, or will he prefer a gradual increase?

The Eurozone Will Recover from the Economic Stagnation

After nearly a year and a half of economic stagnation, economic growth in the Eurozone is expected to accelerate in the second half of this year. Strong wage growth will provide some support to European consumers, as high inflation in the past has taken a toll on the real purchasing power of European consumers.

In addition, the Eurozone will emerge from its current negative output gap, suggesting a recovery in economic activity if there is no structural downward revision of the region's growth potential. Finally, the ECB's 50bps rate cut in Q3 should provide some additional economic boost.

European and US Economic Outlooks and Comparison_5

Germany remains a clear underperformer in the region, facing challenges from a tight fiscal stance, high energy costs, and sluggish global demand for its industrial export-oriented sectors. Structural issues such as a lot of red tape and the inability of potential foreign workers to integrate into the labor market put pressure on the supply side. On the positive side, Italy, Spain, and several smaller economies are filling the growth gap thanks to the boom.

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