Curmi & Partners

Still an atypical monetary policy cycle

By Nicole Busuttil

Economies are currently in an unusual policy cycle due to COVID-induced imbalances which are still unwinding. As a result, the monetary policy transmission is still gaining traction and will continue to slow down domestic demand and, in the process, economic growth. However, the pace of the slowdown and its resultant effect remains uncertain.

The US continues to display firm momentum in activity. Retail sales and industrial production have beat expectations in every month since the July reading. Since the start of 2023, the US Composite PMI print has never fallen into contractionary territory, with the final reading for October coming in at 50.7, as manufacturers and service providers experienced a quicker rise in output despite fragile demand conditions. On a quarter-on-quarter annualised basis, GDP growth for 2Q23 was that of 2.1%, 0.1% down from 1Q23 growth. Official estimates show the growth for 3Q23 to be that of 4.9%. All these data prints indicate potential tailwinds to activity for the end of the year and into 2024. According to Bloomberg, yearly GDP growth is now expected to be 2.3% for 2023 compared to the October forecast of 2.1%. However, Bloomberg forecasts for 2024 remain at 1.0% GDP growth.

October non-farm payroll growth slowed to 150,000 job additions, that is the lowest monthly job additions in over two years (excluding June 2023 – 105,000 additions). However, after removing the one-off impact from the UAW strike, economists believe that underlying payroll gains remained elevated, pointing to a still-tight labour market. This, together with the potential tailwinds leading to higher-than-expected economic growth implies that the unemployment rate may not increase as much as originally anticipated. Bloomberg projections are showing unemployment peaking at 4.4% as at 2Q24 compared to the October rate of 3.9%.

With stronger activity and less slack in the labour market, the disinflation story is likely to be somewhat less than initially anticipated. Bloomberg forecast headline inflation to come down to 3.1% in 1Q24 from the actual print of 3.5% for 3Q23, before reaching 2.3% in 1Q25. Previously, the forecast was of a further decline to 2.9% in 1Q24, before reaching 2.4% in 1Q25. In the face of the upward revision in the inflation forecast, along with the stronger projected activity and tight labour market, analysts are expecting another rate hike in either December or January as both the inflation and employment data will see the Fed becoming increasingly concerned with achieving price-stability. Furthermore, analysts are seeing only one rate cut in 4Q24 as opposed to the three cuts previously forecast. According to Bloomberg, markets are currently pricing in no more rate hikes before seeing the first rate cut in the first quarter.

The Euro Area on the other hand has barely grown over the past year. On a quarter-on-quarter basis, the economy saw nil growth during 1Q23, in line with 4Q22, followed by 0.2% growth in 2Q23 and an estimated contraction of 0.1% in 3Q23. The area’s Composite PMI has been in contractionary territory since June 2023, reaching a new low of 46.5 in October. As a result, analysts have revised down their near-term growth forecast, now expecting a mild technical recession in 3Q/4Q23 and a recovery that gains steam in 2025. On a quarter-on-quarter basis, Bloomberg’s official estimate is for a contraction of 0.1% for 3Q23, while forecasting nil growth for 4Q23. These are compared to the October forecasts of nil growth for both months, respectively.

The disinflationary momentum in the region has continued. Despite recent inflation prints showing the disinflation progress has slowed, with wage growth in Germany accelerating, Barclays’ real-time wage tracker for negotiated wages excluding one-offs remained at 4.0% year-on-year for the third straight quarter. Based on this, we continue to expect inflation to decelerate further, but potentially at a slightly slower pace, primarily due to strong base effects and wage dynamics. Bloomberg forecasts inflation to continue to fall to 3.2% in 4Q23 from 4.9% in 3Q23 and keep falling in 2024, ending 4Q24 at 2.2%.

No growth and disinflation are an offshoot of the ECB monetary policy transmission. The monetary policy stance now seems to be restrictive. Therefore, we expect the ECB to keep rates steady at the upcoming meeting. Analysts expect the ECB to remain on hold until 2H24 and to cut rates thereafter. According to Bloomberg, markets are pricing in zero rate hikes and rate cuts as from 2Q24.

Therefore, the monetary policy cycle is still uncertain with probable policy divergence in 2024 and beyond as the Fed may hike again unlike the ECB, with the latter potentially implementing rate cuts ahead of the Fed next year. However, expectations may change drastically overnight depending on upcoming published data.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.