The fight against inflation has not yet been fought. This means that further monetary tightening is likely to continue, especially in the United States, where the strength of the labour market continues to surprise.
United Kingdom
In the UK, the Bank of England can further raise its key policy rate to a maximum of 4.5% in May, and maintain it until the second half of 2024. This contrasts with current market expectations that assume interest rate cuts in the second half of 2023.
According to Vanguard, a recession has begun in the UK this quarter and will last until the end of the third quarter of 2023.
U.S.
A stunningly strong labour market report from January showed that the Federal Reserve (Fed) still has work to do. The U.S. economy created 517,000 jobs in January. That’s the highest monthly number since July 2022, when the US central bank’s policy rate was more than two percentage points lower than today’s 4.5% to 4.75%.
After almost a year of aggressive interest rate hikes, the Fed has not yet significantly affected the job market, given the drop in US unemployment to 3.4%, the lowest figure in 54 years. As the US Consumer Price Index rose 0.5% in January compared to december, Vanguard expects US inflation to remain high in the first quarter.
A tighter monetary policy needs time to work through in an economy. Vanguard predicts that unemployment will only rise towards 5% by the end of this year. The asset manager further assumes that during its next two meetings, the Fed will increase its interest rate policy to a range of 5% to 5.25% and keep it there throughout 2023.
The asset manager has raised the eurozone growth forecast for 2023 to 0%. Previously, Vanguard assumed a contraction of 0.5% to 1%. The forecast for the average inflation in the eurozone for this year has also been adjusted, from 6.1% to 4.5%. Rapidly falling natural gas prices, a resilient industrial sector and a revival of the Chinese economy are helping to soften the difficult economic outlook.
However, the underlying momentum is weak and Vanguard continues to assume a recession that begins this quarter and lasts for two quarters.
The European Central Bank will increase its main deposit rate to 3.5% in the second quarter, Vanguard said, with two increases of a quarter percentage point after the already announced increase of half a percentage point in March. A rate cut is to be expected in the second half of 2024 at the earliest.
After two years of lockdowns, China has moved away from its zero Covid policy in a short time. As in developed markets, Chinese consumers will spend part of the savings surplus they accumulated during the pandemic. This stimulates domestic growth and reduces the likelihood of a global recession. It can also boost growth in emerging markets, especially in Asia, and support exporters in the eurozone.
