Economists counter market bets of soft landing
Headline inflation is declining at a sharper-than-expected pace © Bloomberg We’ll send you a myFT Daily Digest email rounding up the latest Global Economy news every morning.
Economists are at odds with markets over investors’ optimistic bets that the global economy is set for a soft landing and interest rates are close to their peak.
Markets have rallied on both sides of the Atlantic in recent weeks, as the UK followed the US and eurozone in showing headline inflation is declining at a sharper-than-expected pace.
“In all the major regions we have this sense of light at the end of the tunnel,” said Claus Vistesen, chief eurozone economist at consultancy Pantheon Macroeconomics.
The improvement in the UK, where a fall from 8.7 per cent to 7.9 per cent represents the biggest single month drop on record, was “the last shoe to drop”, he added.
While few now expect the deep recession that many forecast last year, many economists caution that central banks will struggle on the “last mile” of their journey to bring inflation sustainably back to their 2 per cent targets without raising rates so much that job losses mount.
With central bankers in the US and eurozone meeting this week, and their UK counterparts convening next Thursday, investors hope that the latest good news on inflation will mean rate-setters moderate their plans to keep raising borrowing costs.
Markets have priced in a near certainty of a further quarter point increase in interest rates from the Federal Reserve on Wednesday, but investors are betting that this will prove to be the peak in US rates and that the Fed could start loosening policy early in 2024.
The European Central Bank is also expected to plump for a similar rise meetings next week, and an increase of at least that size is forecast from the Bank of England next month.
Investors no longer expect UK rates to surge as high as the 6.5 per cent they bet on just a few weeks ago. Some think the ECB may also be close to a pause, after Klaas Knot, usually one of the most hawkish members of the ECB’s governing council, said on Tuesday that rates increases beyond the July meeting were “by no means a certainty”.
However, economists are not convinced that the better data means growth over the coming quarters is assured.
Some argue that the lagged effect of higher interest rates has yet to be seen and that economies are set to slow sharply.
Others say that, if economies do prove resilient and jobs markets remain strong, central banks will end up having to take a harder monetary stance than markets are pricing in.
Unemployment remains near historic lows on both sides of the Atlantic and official data shows wages growing faster than central banks think compatible with 2 per cent inflation.
Robert Sockin, global economist at Citi, said it would be “historically unusual” for central banks to get inflation back to target without “a meaningful loosening in labour market conditions”.
“We need to see unemployment going higher [before central banks stop raising rates],” said Luigi Speranza, chief economist at BNP Paribas. He still believes that the lagged effects of higher interest rates will produce a recession in the US and a long period of slow growth in the eurozone, where inflation is now 5.5 per cent, down from 10.6 per cent last October.
Some economists think a soft landing could occur in the US, where inflation has fallen from double figure to just 3 per cent. Goldman Sachs now sees only a 20 per cent chance of the US economy entering a recession in the next 12 months, citing “the easing in financial conditions, the rebound in the housing market and the ongoing boom in factory-building”.
Adam Posen, president of the Peterson Institute for International Economics, said US inflation could come down without a recession in an economy where labour traditionally has less bargaining power.
But it would be a “heroic assumption” to expect inflation to evolve in a similar way in the eurozone, where workers had stronger rights. Eurozone PMI data out on Monday signalled the region could be heading for another quarter of economic contraction.
In the UK, meanwhile, Posen said policymakers had lost credibility and were trying to hold down public sector pay unsustainably.
Although the government has settled some pay disputes, and headed off strikes by teachers with a new pay offer of 6.5 per cent, it has yet to resolve a damaging dispute with the main doctors’ union. It would be a much bigger task to reverse a 15-year period of attrition in the relative value of public sector pay, which has led to worsening problems with recruitment and retention.
In the private sector, figures published this month by Indeed, the online jobs site, show that growth in advertised wage rates has slowed sharply in the US, while plateauing in the eurozone and still accelerating in the UK.
Dave Ramsden, the BoE’s deputy governor for markets, appeared last Wednesday to caution investors against over-interpreting the latest inflation print. Price pressures were still “much too high”, he said, underlining that rate-setters were focusing on wage growth and services inflation.
For now, though, even some in the UK are focusing on the positives.
“Disinflation is back,” said Michael Metcalfe, head of global macro strategy at State Street Global Markets.
Paul Dales, at the consultancy Capital Economics, said that while he still expected UK output to shrink, successive contractions that together amount to around 0.5 per cent would be “the mildest recession we’ve ever had”.
Given how much bleaker the UK’s prospects looked at the start of the year, he said, “that would still be classed as a really good result — essentially a soft landing”.
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