Intesa Sanpaolo : Doubts about the ‚last mile‘ in the fight against inflation have led investors to further scale back expectations of close rate cuts by central banks: now a first full cut is only expected at the June meetings of the Fed and ECB (in line with our expectations, which until a few weeks ago were largely out of line with the market).
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Weekly Economic Monitor – 16. February
Intesa Sanpaolo – Research Department
Next week, new information may come from the release of the minutes of the last meeting of both central banks.
United States. The event of the week was the January CPI, which surprised upwards: the rise of the core CPI (accelerating to 0.4% m/m, stable at 3.9% y/y), largely due to services, is consistent with a core consumption deflator rising by 0.25-0.3% m/m in January (given the smaller weight that housing services have on the PCE), and slowing on annual basis to 2.7% from 2.9%. After the data, markets further adjusted their expectations on the timing of the Fed’s rate cuts: futures are now discounting a full 25bps cut only at the June meeting (in line with our expectation, which until a few weeks ago was largely out of line with the market); there remains a gap between our estimate of 75bps overall cuts this year and the 93bps now priced in by the market (down sharply from 116bps last Friday, and the 150bps expected in early January).
Confirmation of the persistence of inflation also came from the Atlanta Fed’s ‚Sticky-Price CPI‘ index, according to which inflation on items that change price relatively slowly was 6.7% (6.8% core) at 1 month (annualised) and 4.6% vs 12 months earlier, and from the median CPI published by the Cleveland Fed, which rose to 0.5% m/m and 4.9% y/y in January. Also, the increase in import prices in January (0.8% m/m, 0.6% net of oil) is not a particularly encouraging sign for the continuation of the disinflationary process.
On the cyclical front, Empire Manufacturing and the Philly Fed showed an upturn in February, but January’s retail sales figure showed a surprise decline (-0.4% m/m from 0.8% before, on the ‘control group’ aggregate, the most related to national accounts consumption). This could be a first sign (to be confirmed in the coming months) of weaker household demand, which has been the main driver of GDP in 2023; however, the figure (as well as the drop in industrial production in the same month: -0.1% m/m) may have been affected by the particularly adverse weather conditions.
In this context, some FOMC members such as Barkin (voting), Collins and Logan (non-voting) admitted that inflation fell faster than expected in 2023, but added that a more extensive reduction (probably in time, rather than in the magnitude of declines) in inflationary pressures is needed before official rates should be cut.
This week came the update of the federal deficit forecast by the CBO in the ‚Budget and Economic Outlook 2024-2034‘: the deficit for the fiscal year 2024 is expected to be USD 1.4 trillion lower than estimated in May 2023, mainly due to the reduction of discretionary spending induced by new legislation (the Fiscal Responsibility Act); as a percentage of GDP, the deficit for the fiscal year 2024 stands at 5.6%.
The macroeconomic calendar next week will be light: the most relevant event is the release of the FOMC’s end-January minutes, scheduled for Wednesday 21; on Thursday 22, the preliminary PMI estimates for February could show a further recovery after that already seen in January, and existing home sales in January are expected to rebound around 3.97 million units; the Philadelphia Fed’s non-manufacturing activity index on Tuesday 20 and the CFNAI again on Thursday 22 will complete the picture.
Eurozone. This week, the second estimate confirmed the stagnation of Eurozone GDP in Q4 2023 (in essence, the economy stopped expanding at the end of 2022); at the same time, employment did not stop growing at the end of 2023, indeed accelerating to 0.3% q/q (annual change stable at 1.3% y/y). Industrial production showed a very large recovery in December
(2.6% m/m, 1.2% y/y), which is however explained by the „abnormal“ jump recorded in Ireland (and, to a lesser extent, in the Netherlands), as well as by seasonal anomalies that supported French output (and the 1.1% growth recorded in Italy is nothing more than a partial rebound after the previous month’s drop). In any case, surveys are showing signs of stabilisation of the cycle; indeed, there are improvements, but they remain confined to expectations (the German ZEW in February rose for the seventh consecutive month), mainly due to expectations of rate cuts (which, however, will act on the economy with a delay), while economic operators‘ assessments of the current situation remain depressed (in the case of the ZEW, at the lowest since June 2020, in the midst of the first pandemic wave).
Overall, we confirm our growth estimate of 0.4% for the euro area economy in 2024, as the signs from the surveys do not yet appear consistent with a vigorous recovery already in the first half of the year. This estimate is slightly below the consensus (0.5%) and significantly lower than the Winter Economic Forecast just published by the EU Commission, and the December ECB staff projections (both at 0.8%).
On the inflation front, we recently revised down our estimates for the price of natural gas in Europe (TTF) to just under EUR 31 (from a previous EUR 36) per MWh on average in 2024, and to EUR 28 (from EUR 30) per MWh in 2025. The effect on Eurozone inflation is moderate: the annual average remains unchanged for the current year (at 2.5%), and falls by just one tenth next year (to 1.8%). In any case, in our view the recent evolution of gas prices, when compared with the technical assumptions made by the ECB in last November’s staff projections (EUR 47 and EUR 44 per MWh in 2024 and 2025, respectively) justifies ceteris paribus a downward revision of about two tenths on the 2024 HICP and at least one tenth on 2025 (from 2.7% and 2.1% respectively in December). The realignment of the 2025 inflation estimate to the ECB target in the new March projections would open the door to a rate cut in the following months.
In her speech to the EU Parliament, Christine Lagarde stated that the ECB does not believe for the time being that it has sufficient evidence of a stable return of inflation in line with the 2% target, and that ‚hasty‘ decisions should be avoided. The biggest concern is that past price rises will result in persistent wage pressures: in this respect, the outcome of ongoing or upcoming rounds of negotiations affecting a large share of workers will be crucial; according to Lagarde, “the ECB’s forward-looking wage tracker continues to signal strong wage pressures, but agreements indicate some levelling off in the last quarter of 2023”. Moreover, the contribution of unit profits to domestic price pressures continued to decline, suggesting that, as expected, wage increases are at least in part buffered by profit margins. Very dovish tones came from Panetta in his speech to the ASSIOM FOREX Congress on Saturday: the Governor of the Bank of Italy pointed out that the three-month change in consumer prices was already steadily lower than the twelve-month change, and was at or below 2% even for core inflation and services. Panetta also stated that at this stage, the effects of monetary tightening are proving to be stronger than both historical experience and past ECB estimates, and will continue to weigh on the economy at least through 2024. Finally, Panetta’s view is that there are downward pressures on the natural rate of interest stemming from the decline in international trade, the increased fragmentation of global value chains and obstacles to capital mobility; these pressures are on top of pre-existing trends stemming from the effect of an ageing population, slowing productivity and the growth in demand for risk-free securities outstripping supply. Villeroy de Galhau (France) and Scicluna (Malta) are in favor of a gradual rate cut, but initiated quickly; instead, Schnabel reiterated concern about a rebound in inflation and, therefore, a preference for a wait-and-see attitude.
Overall, investors have further reduced their expectations of rate cuts by the ECB over the past week, mainly due to US data; however, markets continue to discount larger rate cuts for the ECB than for the Fed over the course of 2024 (110 versus 93bps), and the probability of a cut before June is slightly higher for Frankfurt. At the moment, we maintain the view of lower overall cuts in 2024 than those priced in by the markets for the ECB as well. We also confirm a baseline scenario that sees a first ECB cut in June as for the Fed, but we agree with the view that the probability of an earlier move (in April, in the case of the ECB) at this time is higher for the ECB than for the Federal Reserve. On Thursday 22, the accounts of the latest monetary policy meeting of the Governing Council held on 24-25 January will be circulated.
Next week’s February confidence surveys in the euro area should confirm the picture of cyclical weakness in early 2024. The flash PMIs could show a slight increase in the manufacturing index to 47.1 from 46.6 in January, to still recessionary levels (as in January, part of the increase could be explained by a further lengthening of delivery times due to shipping delays caused by tensions in the Red Sea). The services PMI is also seen rising, to 49 from 48.4, bringing the composite indicator to 48.6 from 47.9, a high since last summer. We expect essential stability for national surveys: we see the IFO increasing slightly to 85.6 from a previous 85.2 – which should however not materially change the recessionary outlook of the German economy, and INSEE manufacturing unchanged at 99. After the unexpected drop in January, the European Commission’s consumer confidence index may show a slight recovery (to -15.7 from -16.1), at levels still consistent with substantial stagnation in consumption even in early 2024. Finally, the final inflation estimates for January in Italy and the Eurozone as a whole are on the calendar, as well as the second reading of German GDP for Q4 2023.
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