Western Europe Outlook: Easing Cycle Underway?

Our Forecasts

Risks to Our Views

Even More Common Themes as Rate Cuts Loom

The cross currents we have highlighted across Western Europe’s economies seem to be getting clearer and broader, now to a degree that all for central banks considered here monetary easing is now on the agenda. That reflects very much a more consistent picture of all those institutions having seen a clear fall in their respective targeted inflation measures and where an ensuing policy debate is emerging about the degree to which current clearly restrictive stances can be at least partly unwound.  This is very much evident in Figure 1, where the seasonally adjusted CPI measures we have computed (and flagged in recent Outlooks) are largely now consistent with those targets having already been met.  Admittedly, there is some noise in that in the UK and Switzerland disinflation process that may have stalled, but amid the weak activity picture we see collectively we think price pressures are hardly likely to reverse.  In this regard, we have again made little alteration to the 2024 growth outlooks for all four countries, they largely remain below consensus, not only for this year but (save for the UK) also the case for 2025 too.  In addition, these near recession conditions obviously reflect the growing actual and anticipated further impact of interest rate hikes – this effectively having added to, if not replaced, energy as the concern for beleaguered consumers.  But the impact is already clear in the manner in which all four countries have seen private sector credit slow, if not contract, especially in real terms. To us, this is partly being driven by central bank balance sheet reductions, although, even in Norway where the latter is not occurring, real credit growth is negative.   

As for inflation dynamics it is clear that for the SNB, the underlying inflation picture has never been that intense and has eased nonetheless of late, despite Switzerland showing the least weak activity backdrop.  For the UK, the still large MPC majority to keep policy on hold may partly reflect the manner in which softer price pressures signs have arrived only of late, this also very much being the case for the Norges Bank.

This brings up to what we would regard as the final theme, albeit one based on extrapolating the softer core price signals seen in Figure 1, this being something we think is sensible given the downside activity risks we see through 2024. Indeed, this recession-like picture not only reinforces an outlook likely to see collective price pressures dissipating on a sustained basis but also means that central banks are likely to see a real economy backdrop into 2024 that surprises on the downside.  The result that all four central banks will have both the scope and rationale to continue cutting rates and probably well into 2025!

Figure 1: Short-Run Core CPI Trends Continue to Wane

Source: CE- computed seasonally adjusted core m/m measures, smoothed

UK: Fragile Recovery?                                                                                                           

Whether the UK economy is in recession, however, mild, or has merely be stagnating, misses the point.  Either underscore weak activity which we think will accentuate the fall in inflation seen of late which we suggest hitherto has been a more a result of an easing in supply pressures – actually a view that the BoE partly embraces.  But after two successive q/q falls, there are some signs that look as if the economy is recovering, albeit with the pick-up possibly nothing more than a continuation of the monthly swings seen of late.  Notably, the data do also suggest that any such apparent recovery, and in contrast to the message of business surveys, is still very much dependent upon non-cyclical parts of the economy, in particular public services, which are likely to come under pressure from spending restraint even before the medium term.  The PMI data also excludes construction and retailing, perhaps the key sectors most affected by policy both monetary and fiscal. Partly as a result, we remain cautious on the scale and pace of recovery although it now looks more likely that the economy this quarter will grow by 0.1% q/q. 

Figure 2: Tentative Recovery – But PMI A Poor Guide to GDP Swings?

Source: Markit, ONS

Regardless, we still adhere to a relatively gloomy scenario, which still sees nothing better than zero growth in 2024. Even so, there are supportive factors: not least the marked drop in wholesale energy prices which will filter through in another bout next quarter and where the fiscal situation is going to be little more supportive than previously envisaged. But businesses are losing much of the energy support cushion through 2024.  However, the main concern is clearly the impact of the sizeable tightening in monetary policy that is already causing tighter financial conditions not only in terms of higher debt servicing but also in much higher rents.  All will increasingly bite the economy through the credit channel, this very much highlighted by unprecedented recent declines occurring in both the level of bank credit and bank deposits.  This fragile outlook is very much led by the consumer, the most exposed to likely outright damage from the housing market. 

Admittedly, there are brighter signs regarding housing.  But the level of transactions is still low and perhaps still falling, this being the main factor that will affect and weigh on consumer spending, through the year to a degree that very much risk the 0.3% rise in 2023 being reversed, especially as the tax burden is still on the rise as frozen tax thresholds bite harder.   This demand weakness is perhaps made clearer by the fact that the nominal and per capita growth outlook are even weaker, most notably the latter which has dropped in the last seven successive quarters and is seen falling further this year by the likes of the Office of Budget Responsibility.  Against the political issue of immigration, the question therefore is the extent to which growth in the future may have to rely on workers from abroad, something seemingly more likely given updated UK population estimates, pointing to an increase in the size and growth of the UK population, albeit where the impact on demand and supply risks being minimized by rising levels of inactivity.  It is with these considerations and where the most clear-cut drop in inflation and this repair to spending power has already occurred that we still see nothing better than 1.1% GDP growth next year, this possibly a reflection of ebbing potential GDP growth and a picture more in line with consensus thinking.

As suggested above, the fiscal side is hardly going to be supportive not least as the fragile recovery keeps public borrowing nearer 4% of GDP out past 2025, this in turn pulling the debt ratio (now over 88%) higher still.  This is something that may start to resonate more with markets perhaps and which may mean that the likely Labour government (after a presumed election later this year) may have to focus more on political issues such as the EU.

This consumer weakness has helped curtail imports but the latter will recover somewhat from current depleted levels, while Brexit related distortions and a slower global economy weigh on exports. As a result, the likely less-negative current account deficit of last year (down to around 3% of GDP) may not improve further in either 2024 or 2025.  But some recovery in imports will act as a safety-valve in helping restrain what already seems to be waning domestically generated inflation, the latter having started to show more definitive signs of slowing of late given the drop in the core and m/m measures (Figure 1).  The combination of continued supply side improvements and weak demand will bring CPI inflation down somewhat further and durably so.  Indeed, we have pared back our 2024 CPI outlook by 0.2 ppt to 2.3% and inflation mostly below the 2% target next quarter and most of the period to end 2025.

As for the BoE, after 14 consecutive hikes, dating back to December 2021, and encompassing 515 bp of cumulative tightening, the BoE now looks to be reassessing.  Admittedly, and despite recent CPI underlying falls, the MPC majority continue to focus on assessing how ‘persistent’ are price pressures.  However, while the MPC still suggests policy needs to remain restrictive for sufficiently long to return inflation to target, it appears more open in accepting that the stance of monetary policy could remain restrictive even if Bank Rate were to be reduced.  Indeed, an implicit easing bias was evident in the Committee still keep under review for how long Bank Rate should be maintained at its current level. Clearly, a fuller policy review will take place with an updated Monetary Policy Report at the May 9 MPC meeting and the first cut could even arrive at that juncture or leave open a move in June  We think this will pave the way for around a total 100 bp of cuts this year and something similar in 2025.

Sweden: Riksbank Accepts Case for Less Restriction

Amid still weak activity signs, especially discounting recent very cold weather than has boosted energy consumption, perhaps the main news of late has been a continued and broad fall in inflation.  This is very evident in seasonally adjusted m/m core CPI readings (Figure 1) which have showed a much softer profile of late, very much hinting that inflation undershoots target earlier than that circa-Q1 2025 forecast by the Riksbank.  We think CPIF inflation may drop below target by mid-year, especially after the February data which undershot Riksbank thinking of CPIF inflation, at 2.5%, by 0.4 ppt.  This drop has persuaded us to revise down our CPI projection by 0.6 ppt this year to 2.7% but where the 1.8% 2025 projection remains intact, a picture that is now being acknowledged by the Riksbank (see below).   

Regardless, the recession is very clearly continuing, this evident in official data as well as in business and consumer survey numbers which suggest the current quarter will see a fourth successive q/q drop.  Very much this reflects Riksbank policy that is biting strongly, not surprising given the extent of rate hikes but also the speed with which they hit Swedish activity due to the mortgage market being skewed so much to variable rates rather than fixed.  Perhaps most discernibly, this is hitting the housing market, with an absolute plunge in transactions that we do not see being repaired until well into the coming year, if not longer. But we continue to think that Riksbank policy is also biting unconventionally as its balance sheet reduction has caused a marked drop in bank deposits of almost 6% in the last 18 months and where this weakness is affecting banks willingness/ability to lend and is thus accentuating demand driven weakness in credit growth. Indeed, private credit growth is contracting clearly (Figure 3), chiming with the drop in bank deposits. With this in mind, we see the current contraction in Swedish GDP persisting so that the cumulative drop will be well over 1% (this assumes a modest recovery from Q2 this year).  However, the risks are skewed to the downside, not least given the weakness in neighboring economies and the uncertainty about the banking backdrop.  There will be no boost from fiscal policy, the slight opposite given budget plans for 2024, although the actual headline budget gap may rise slightly to just under 1% of GDP this year and remain there in 2025. Regardless, we have made only minor adjustments to our GDP outlook.  After zero growth on average in 2023 GDP, the real ‘story’ remains the further stagnation for the 2024 picture, this upgraded by 0.1 ppt to a still somewhat below-consensus fall of 0.1%, albeit not dissimilar to existing Riksbank thinking.  But the recovery that starts this year may still only generate a par-type outcome in 2025 of 1.5%, also very much below consensus thinking.

In terms of detail, the erosion of households’ purchasing power has contributed to a sustained decline in household consumption since H1 2022 and with a 2%-plus drop last year.  Some recovery will emerge in 2024 as inflation falls but the 2024 pace may be barely positive, impaired by the emerging rise in unemployment with the rate moving decisively back above 8% in 2024.  This should mean that wage growth next year may fall from last year’s 3.8%. As telling is the likelihood that housing construction (which has already fallen steeply due to lower house prices, higher construction costs and more expensive financing) continuing to contract this year. Even so, house prices (already down some 15% from the peak of early-2022) may fail to recover much even on the anticipation of earlier Riksbank easing.

But exports will also fare less well into 2024, but with still soft imports meaning that with the current account surplus possibly rise towards 5% of GDP this year and persist in to 2025.  All of which will result in an output gap of over 2% appearing through 2024, effectively a 4 ppt swing in two years!

Figure 3: Swedish Credit Growth Increasingly Negative

Source: Riksbank, % chg y/y

It is ever clearer that the Riksbank has accepted that it can and should make its policy stance less contractionary, at least in conventional terms.  In its last decision, at the start of February, keeping policy at 4%, albeit increasing the pace of bond sales from SEK 5 bn to 6.5 bn per month, it noted that the possibility of the policy rate being cut during the first half of the year cannot be ruled out, this contrasting to the H1 2025 schedule in its last set of formal forecasts released last November. Surely this possibility has risen given the further downside inflation surprise we have already highlighted.  A June cut has long been our view, the question being whether this is formally flagged by the Riksbank in its updated projection due alongside the almost-certain stable decision due on Mar 27.  More likely, the Board may wait to the May 8 verdict to offer any formal signal.

While this hint of earlier rate cuts is not a Riksbank commitment, it is nevertheless a reflection of reduced worries about the krona, an acceptance that the inflation outlook has improved durably while the economy is weak, all suggesting that the stance of policy has scope and rational to be less restrictive.  The Riksbank thinking may also be that by easing earlier it can ease more gradually and or with more flexibility. This change of heart chimes with our forecast anticipating rate cuts from Q2, and some 100 bp by end-year. 

Switzerland: SNB Starts to Ease

Modest or subpar GDP growth has been the norm of late, this actually being in accordance with our long-standing view. Indeed, survey data are weak, particularly regarding manufacturing and the consumer (Figure 4), actually very much consistent with the downside risks that still beset our projections into 2024 and beyond.  They range from the risk of property and financial market corrections to the transmission of monetary policy turning out to be stronger than currently assumed.  Additional risks include even more spill-over from weakness in Germany and also a possible energy shortage in the coming winter 2023/24 albeit where Switzerland is partly insulated from this given its large nuclear and hydro reliance – the latter accounting for a good proportion of recent GDP advances.  It could be argued that the sharp fall in inflation seen of late (and which chimes with our forecast offered three months ago, namely average CPI inflation at 1.5% this year and two notches lower in 2025), will provide some respite to what has been damaged household spending power.  But as Figure 4 also highlights consumers are still more convinced that inflation is still high and at levels somewhat above the 2% SNB target. It is unlikely that any further actual disinflation will occur, with consumers possibly very mindful of recent rent and energy price increases. Even so, real wages may rise only modestly given the high probability of continued wage restraint across all sectors, albeit this offset by solid jobs growth.

Overall, we largely adhere to our (December) GDP projection for 2024 of 0.8%, this slightly below consensus and the recently revised SNB projection (here).  But reflecting what we think will be a weak EU and particularly German recovery into next year, we still envisage nothing more than a return to almost trend growth of around 1.2% in 2025.  In terms of detail, consumer spending is likely to provide some support, given the sound labour market situation although we do see the jobless rate inching higher into 2024. Otherwise, the Swiss franc's recent strength, coupled with sub-par global demand, will continue to hurt goods exports.  Meanwhile declining capacity utilization and the lagged effect of higher interest rates will curb investment activity, with the risk that the decline in construction investment continues through 2024, the latter factors acting to slow import growth.  As a result, the current surplus may stay just around 9% of GDP in both 2024 and 2025.  As for policy, it is biting, most notably in terms the clear slowing in private credit which at under 2% y/y is the lowest since 2016. The credit slowdown is also demand driven, reflecting the clear softening in property prices (most particularly for apartments) which will extend through the coming year.

Figure 4: Swiss Consumers Still Very Cautious

Source:  SECO

As for policy, the SNB this month became the first DM central bank to cut rates with a 25 bp reduction to 1.50%.  This move reflects an even larger forecast inflation undershoot and is also designed to counterbalance the strong Swiss Franc.  Indeed, the inflation forecasts for 2024 and 2025 were significantly lowered even with the new 1.50% policy rate, which suggests that a further cut is highly likely in both June and September.  A December cut is possible, but will depend on the September inflation forecast and how the currency is performing.  

The SNB also appears to remain keen to intervene to restrain the Franc, but wants the FX market to understand that it can move quicker than other central banks on interest rate reductions as well. It is noteworthy that the SNB had already started to the reverse the policy course it initiated some two years ago, having dropped formally in December plans of further FX sales.  But now it is seemingly doing the opposite to a degree that is seeing its balance sheet re-expand due to CHF sales to curb currency strength.

Norway: Stagnating as Inflation Buckles

With some m/m volatility made all the more marked of late by swings in the weather, the economy (at least outside of oil services) is stagnating still into this year.  It has been succumbing to the downside pressures being exerted by both monetary tightening and the weakening growth elsewhere in W Europe and beyond.  Indeed, activity dynamics (including a sharp slowing in private sector credit growth, Figure 5) are hardly positive.  But the current cold snap boosting energy usage so far this quarter and a better carry over from end-2023, have persuaded us to upgrade the GDP outlook, with the growth rate this year revised up 0.2 ppt but still to just 0.3%, this being very much below consensus but more in line with the recently revised Norges Bank outlook.  Indeed, a recent regional survey compiled by the latter actually points to GDP declining afresh in early 2024.  A recovery is still seen in H2 next year and this should continue into 2025, albeit with nothing more than a trend rate of 1.3% and with downside risks attached to this consensus-like forecast.

This view very much reflects 2024 seeing a second successive year of flat gross investment, albeit with a drop in construction almost certain through 2024.  But the gloom is centered on households; after a clear fall in consumer spending last year, we do not see any recovery in 2024, especially as the recent stabilization in house prices is fragile and unemployment starts to rise (as is likely).  Indeed, reflecting this, consumer confidence remains near a record-low, not surprising after a likely drop in real disposable incomes of around 4% in the last year. This is in spite of the fall in inflation now very much unfolding, with the CPI-ATE measure undershooting Norges Bank projections, albeit  a little above our expectations.  Hence, we have revised higher the anticipated average rate for CPI inflation this year to 2.8%. This also encompasses the headline rate hitting 2% by H1 next year and then remaining there through 2025.  This is hardly surprising as the next two years should see an output gap persisting and averaging nearly 1% of GDP.  Indeed, more reassuring signs are already emerging increasingly on a broad front too, with m/m adjusted data increasingly showing signs of buckling (Figure 1). But the recent weakness in the krone, which the Norges Bank is clearly trying to address with its policy rhetoric, should dissipate, if not reverse, meaning that through2024, imported price pressures subside, thus adding to recent softer domestic signals. As a result we think the Norges Bank is too gloomy is assessing inflation still being above target even out to 2026!

Figure 5: Household Credit Growth Negative in Real Terms

Source: Norges Bank, Stats Norway

As for Norges Bank policy, the Board left rates at 4.5%  for a second successive meeting this month, retaining the thinking first aired at the December meeting, namely the ‘policy to stay on hold for some time ahead’.  It accepted a softer recent inflation backdrop but revised up its real activity backdrop so that the recent price undershoot dissipated through 2025 due to a smaller output gap.  Indeed, it adhered to its existing policy rate projection suggesting no cuts before this autumn.  However, it is clear that the Board is uncertain.  But the overall policy outlook is still balanced as it weighs risks of earlier easing (hurting the currency) against waiting too long.  Not least against a backdrop where the updated projections seem to take no account of likely looming rates cuts by other central banks, we think he Board is being too cautious and we still think rate cuts may arrive by mid-year, especially given the more recent drop in underlying price pressures. Indeed, we have long thought the Norges Bank has been too hawkish, not least given its own projection of an inflation overshoot persisting out to 2026. Instead, recent inflation dynamics makes us envisage a 25 bp cut in June.  Admittedly, this is actually less of a cut than what we were previously anticipating for the whole of next quarter, but it is still more than markets and/or the Norges Bank have pencilled in.   Regardless, we still forecast 100 bp of rate cuts in 2024 and a same-sized drop through 2025.