SSGA: Q1 Eurozone forecast - Walking the Tight Line

SSGA: Q1 Eurozone forecast - Walking the Tight Line

January 30, 2024

Outlook Eurozone
Eurozone.jpg

The global economy still appears set to slow in 2024 against the backdrop of continuing disinflation, but the shift to a more dovish stance in central bank messaging lessens the chances of a recession materializing in the coming year. Focus now shifts to when rate cuts may happen.

Having made no changes whatsoever to our eurozone forecasts in September, we tweaked them at the margin in our latest update. Growth estimates for 2023 were reduced by a tenth to 0.6%, with 2024 projections down two tenths to 0.9%.

With these changes, we remain modestly above consensus. We still do not have a formal recession in the forecast, but these projections are far from genuinely upbeat. While we retain the view that eurozone macro resilience is insufficiently appreciated by investors, the region will battle meaningful fiscal headwinds and an approaching corporate refinancing wall over the year ahead.

On the plus side, the significant disinflation of recent months speaks favorably to rising real disposable incomes and the record low unemployment rate suggest an even tighter labor market than in the United States. Moreover, given the rigidities associated with European labor markets, we suspect any possible uptick in the unemployment rate will be extremely slow and shallow.

With elevated excess savings and household net worth, European consumers have the money. They just don’t have the confidence. Our expectation is that confidence returns as inflation gets closer to target and interest rates begin to decline. That could spur a mild pickup in consumption and lift GDP growth modestly.

The improvement in inflation has been quite remarkable. Even as recently as 3–4 months ago there was broad skepticism towards the idea that the eurozone would join the US in earnest along the disinflation path. And yet, both headline and core inflation are now lower in the eurozone than in the US.

Still, we should recognize that the speed of this improvement is somewhat artificial (linked to distortions introduced in changes to energy subsidies over time) and progress will slow markedly from here on (and likely even reverse temporarily). It is with this in mind, and also with an eye to elevated wage inflation, that we see market pricing of tECB cuts as a little too aggressive at the moment.

Rather than the 150 bps worth of cuts envisioned by the market, we think 100 bps is a more reasonable expectation. It is possible that the ECB could surprise with more cuts, but given our ‘no recession’ baseline, we are comfortable with the more conservative profile.

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