Economic and financial risk insights: High inflation readings and still strong US economy mean no early rate cut, but they will be coming

• The US economy is sending mixed signals, but we expect it to decelerate. Growth in Europe is still weak but there are signs the worst is over.
• Disinflation continues, but in the US risks have shifted to the upside, with consumer inflation expectations rising.
• We expect the Fed, the ECB and the BoE to begin their rate cut cycles this year, but with caution as they wait more signs of a sustainable return to the 2% inflation target

Growth: US jobs up, but labour market shows signs of strain; mixed signals from the economy
US jobs grew by 275 000 in February, above consensus. However, unemployment rose from 3.7% to 3.9% and wage growth slowed from 0.5% to 0.1% month-on-month. Mixed signals emanate from elsewhere too: consumer loan delinquencies are surging yet commercial and industrial loan delinquencies remain low (see Figure 1).

Figure 1: US delinquency rates for consumer and C&I loans

We expect the US economy to slow as wage growth slows and borrowing costs erode profit margins. In Europe, stagnation is set to continue in 1H24, with January credit data showing no signs of sequential  improvement (see Figure 2).

Figure 2: Euro area annual growth rates (%)  of loans to the private sector
 

However, though still in negative territory, composite PMIs continue to rise, an early sign that the worst may soon be over (see Figure 3). In China, the property market downturn will likely continue to weigh but the recently announced fiscal spend of CNY 1 trillion should support economic growth.

Figure 3: Composite PMIs for the US and euro area

Inflation: disinflation continues, but the path is bumpy with upside risks
Strong demand in the US in 1Q24 has slowed disinflation. Consumer inflation expectations rose by 40 basis points in February (see Figure 4), and headline CPI increased to 3.2% last month, above consensus. The Atlanta Fed's sticky-CPI — an index of prices that change slowly – however, fell to 4.4% from 4.6% a year earlier. On a 3-month annualized basis it ticked up to 5% from 4.8% in January, sending more mixed signals.

Figure 4 : US 3- and 5-year consumer inflation expectations

In the euro area, wage growth and services sector inflation remain elevated (see Figure 5), but we expect a temporary fall below 2% in headline inflation in 2H24, before a slight re-acceleration. In China, inflation in December and January was lower than expected. We have cut our China 2024 CPI forecast to 0.5% from 1.2%.

Figure 5 : Contributions to euro area inflation

Interest rates: central banks cautious; want more evidence of disinflation before cutting rates
Amid a still strong labour market and significant inflation upside surprises, the Federal Reserve will need to proceed very cautiously on upcoming rate cuts. Statements from the European Central Bank's (ECB) Governing Council signal need for more concrete evidence of sustainable disinflation into the medium-term, and we now expect the ECB (and Bank of England) to start cutting in June. If domestic price pressures, including wage growth, remain strong, cuts may be further delayed. The ECB's operational framework review released this week was largely conceptual, and clarifications are expected through the year. Meanwhile, we expect the Bank of Japan to exit its negative interest rate policy in the coming months.

Figure 6: Market-implied central bank rate projections for US and euro area, and SRI forecasts

US economic outperformance to remain. Disinflation to continue but will be bumpy. Central banks will proceed cautiously on rate cuts; US still faces CPI upside risks.

Table 1: Key economic forecasts