Economic and financial risk insights: the wrong kind of reacceleration makes for tough policy choices

• A significant growth slowdown is still most likely in major economies in 2024, despite recent resilience in the US and some euro area economies.
• Energy and food price rises are pushing headline inflation back up in the near term, and core inflation is sticky in the US and Europe.
• The hiking cycle is near an end, but inflation pressures will likely keep policy restrictive for longer in advanced markets. In China and other emerging markets we see further easing.

We see a significant growth slowdown in major economies as still most likely in 2024. Recent activity data in the US show persistent resilience and even some upticks in certain sectors (see chart), but a broad-based reacceleration is not currently visible. Falling PMIs and softening labour demand are both signs of cumulative Fed tightening starting to bite.

Europe is in stagnation although there are divergences between countries, with Germany in contraction due to weak global trade and manufacturing. Yet with the euro area services PMI also slipping below 50 in August (see chart), broader weakness may not be far off. China's growth momentum is also slowing despite policy support so far. In a tail-risk China recession scenario, we estimate a more negative direct demand-led impact on the euro area than the US.¹ Overall, US GDP strength will likely outweigh the relatively smaller spillovers from China slowing.

Too early to declare inflation victory. Energy and food supply side shocks may lift headline inflation again, while we expect core CPI to ease slowly. Oil supply shortfalls drove prices to a 10-months high this week (see chart) and prices are likely to stay elevated in coming months. Meanwhile, US and European labour markets are still tight, which is likely to limit the pace of core disinflation. US core CPI advanced 0.3% MoM in August, the first acceleration in six months suggesting further labour market softening – and time – may be needed.

In Asia, weather-related disruption to rice supply is pushing up food prices, while the US economy's relative strength has led to USD appreciation. That typically means tighter financial conditions and import price pressure for emerging markets, although in China, weak domestic demand still trumps other upside risks. 

We see the latest Fed and ECB rate hikes as likely the last of this cycle, but the unenviable trade-off between persistent inflation and slowing growth will continue to test central banks. In the US, where core inflation pressure remains, we expect the Fed to keep policy restrictive throughout 2024 into 2025 with only a 100bps cut next year. In Europe, the ECB moved in line with our expectations this week and was forced to raise policy interest rates by 25bps due to too-high for too-long inflation, despite overall fragile growth. We maintain our view that the ECB will stay in restrictive territory next year, with rate cuts starting earliest in H2 2024. In China the trade-off is simpler: both inflation and growth are too low. We anticipate a further policy rate cut and other measures in Q4, but the timing and impact is uncertain.

We revise up US growth forecast to reflect the economic strength seen in H1 2023. China's growth forecast is lowered. Interest rates across developed markets are expected to stay restrictive for longer.

¹ However, the interconnections between China and the rest of the world are complex, eg due to financial market channels, so the impact could be highly nonlinear, with more extreme downside risks.