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Italy – 2024-2025 Scenario
The Italian economy proved resilient in 2023, growing 0.9% despite an unfavourable international environment, persistently high inflation and difficult financing conditions owing to rising interest rates. But challenges remain and the outlook for 2024 is still mixed, with growth expected at 0.8%. Italy's growth prospects are undermined by global economic uncertainties, with the slowdown in the world's two largest economies, as well as political uncertainties, with several key elections on the horizon.
But encouraging signs are emerging, particularly in industry. And although its effects are still being felt, the inflationary period is behind us now, the annual rate currently standing at 1.4%, paving the way for an easing of monetary policy. Investment and construction continue to be bolstered by an overhang effect and could benefit from an upside risk linked to stimulus plan support, even though budgetary policy is constrained by substantial imbalances in public finances.
Household consumption remains the big unknown in this scenario. Any recovery remains uncertain despite a handful positive indicators in the second half of the year, the impact of which will be felt more in 2025, with a growth forecast of 0.9%.
France – 2024-2025 Scenario
Economic activity slowed significantly in France in 2023 on persistently high inflation and emphatic monetary tightening. The French economy grew 0.9% over the year (seasonal and working-day adjusted), after 2.5% in 2022, but avoided a recession.
The economy is expected to recover in 2024, with annual growth stable at 0.9% but with higher quarterly growth than in 2023. Annual growth is expected to be adversely affected by sluggish activity in the second half of 2023, with a very low growth overhang for 2024 at the end of fourth-quarter 2023. The recovery will be driven by household consumption as disinflation continues, while investment will continue to be impacted by the past tightening of financial conditions.
Growth is expected to increase to 1.3% in 2025, bolstered by persistent strong consumption momentum and the rebound in investment as monetary policy returns to normal. Annual average inflation is expected to fall sharply, to 2.5% in 2024 in CPI terms (after 4.9% in 2023) and 2.1% in 2025.
China is not 1980s Japan and this is both good news and a big problem
Real estate crisis, demographic problems, trade tensions with the United States, concerning debt levels: multiple comparisons can be drawn between China today and 1980s Japan, sparking fears of a "Japanification" scenario for the Chinese economy. Such a scenario is characterised by a slowdown in economic activity caused by a drop in private consumption, the advent of a negative, deflation-fuelling price-wage loop and a decline in potential growth.
And yet, Japan never really recovered from its "lost decade": the country, which economists in the 1980s saw as the world's leading economic power, ultimately experienced nearly two decades of stagnating growth and prices.
China is not 1980s Japan, which both gives it an edge and poses a problem. It gives it an edge because it has more leeway in conducting its economic policies. It raises a problem because its level of development and wealth – and therefore resilience – is much lower, exposing it to ultimately harsher scenarios.
That said, China could learn from Japan in order to avoid making the same mistakes, starting with the adoption of clear and transparent communication on policies implemented to re-anchor expectations and restore confidence.
While these parallels may be compelling, if any lessons can be drawn, the nature of China's regime and tightening of ranks around the party and its leader Xi Jinping mean that China will never completely resemble either 1980s or modern-day Japan. Furthermore, the country is still far from overcoming the obstacles in its path in order to revive its growth trajectory.
Spain – Scenario 2024-2025
The Spanish economy is going through the final phase of the inflationary cycle that began in 2021 when global supply chains were disrupted owing to the end of the pandemic and gas prices came under pressure due to the war in Ukraine. After growth of 2.5% in 2023, we expect the Spanish economy to grow more moderately in 2024 owing to rising interest rates and the slowdown in the tourism sector, which is already operating at higher levels than in 2019.
But economic activity will be bolstered throughout 2024 by the lessening impact of past interest rate hikes (starting in the second half) together with the decrease in inflation and acceleration in NGEU spending. Overall, we expect GDP growth to come out at 1.9% this year and increase modestly to 2% in 2025.
Core inflation dynamics will be moderate, in line with the latter part of 2023. We expect headline inflation to fall from 3.5% in 2023 to 3.3% in 2024, but core inflation will fall more sharply, from 4.4% in 2023 to 2.5% in 2024.
The long-term impact of slippage in the public finances in France
In 2019, on the eve of the public health crisis, France’s general government deficit had fallen back below 3% of gross domestic product (coming in at 2.4% in 2019), while public debt as defined in the Maastricht Treaty stood at less than 98% of GDP. As a result of the public health crisis, the public deficit widened to 8.9% of GDP in 2020 as economic activity slowed and various forms of government support kicked in, including in particular short-time working. Public debt surged to nearly 115% of GDP. As the economy recovered from the Covid pandemic in 2021-2022, nominal GDP rose sharply, with the result that the debt ratio fell, with public debt ending 2022 at less than 112% of GDP. This was the easy part of the consolidation process.
Last week, French statistics institute INSEE published the first results of the general government national accounts for 2023. They are less than stellar – far from the targets set out in last autumn’s Budget Bill for 2024 – and suggest that the public finances will have even less room for manoeuvre over the coming years. The public deficit rose to 5.5% of GDP (up from 4.8% in 2022), compared with a government forecast last autumn of 4.9%. While there were already rumours that this target – included in the Budget Bill for 2024 – might not be met, this figure is a setback for the government, whose public finance trajectory out to 2027 was already found to be “unambitious” by the High Council of Public Finance last September and by the European Commission in November. As a result, public debt only fell to 110.6% of GDP at end 2023 (from 111.9% at end 2022), whereas the government had forecast last autumn that it would fall below 110% (to 109.7%).
The main surprise was government revenue, which slowed more sharply than spending in 2023 and, unlike in the previous year, rose much less than nominal GDP. In particular, VAT revenue slowed sharply, corporate income tax was well down and personal income tax rose only slightly, mainly because of the way personal income tax thresholds have been linked to inflation. The rate of tax and social security contributions was similar to what it had been during the pre-Covid period, at 43.5% of GDP (lower than in 2022). Meanwhile, spending did not keep pace with inflation in 2023, which means it declined both in real terms and as a proportion of GDP (to 57.3%), even though the latter ratio was still higher than in the pre-Covid period (2019: 55.2% of GDP). Looking at the detail, operating expenditure rose significantly as a result of the sharp increase in intermediate inputs, including in particular energy prices, while there was only a modest increase in the government wage bill. The social benefits bill increased, in particular for inflation-linked benefits, chief among them pensions, while health benefits held steady (with some increases offset by a decline in Covid-related expenditure). Subsidies slowed, notably as a result of the withdrawal of Covid-related help for businesses. Spending to help businesses and households cope with higher energy prices (price caps) stabilised. Despite recommendations from the European Commission that these measures be withdrawn as soon as possible, France – unlike other European countries – opted to keep this safety net (or at least part of it) in place. The phasing out of these measures should help reduce the public deficit in 2024. Moreover, public investment remained buoyant in 2023 and the debt interest burden eased (to 1.8% of GDP) as the cost of servicing inflation-linked bonds fell.
This recent information about the public finances is bad news for all economic agents. The government is going to have to find the “right” savings for the next few years, failing which it will have to rely on the revenue side of the equation, which will mean raising taxes (an option which thus far appears to have been ruled out), if France is to have any chance of bringing its finances back into line with European rules (probably not until current finance minister Bruno Le Maire has left office). In the short term, this slight slippage is unlikely to have much of an impact on the cost of financing France’s public debt, and in particular on the spread to the German Bund (Germany currently has other issues to contend with), though it appears increasingly plausible that France’s credit rating could be downgraded.
The impact will be felt in the long term. At a time when financing the green transition and climate change adaptation (as well as the digital transition, which could generate productivity gains in France) must become a priority and will also have to be paid for out of the public purse (notably because of the existence of externalities), the amount of room for manoeuvre is shrinking ever further. And let’s not forget that debts are meant to be repaid, which means today’s households and businesses (and, no doubt, tomorrow’s even more so) are the ones who will have to shoulder the cost.
World – Macro-economic Scenario 2024-2025
“Normalisation” is on the horizon, but bumps in the road are likely. Interest rates have not bitten quite as hard as expected, while the labour markets have generally held up well, and inflation is subsiding. However, in the US, inflation may settle above the Fed’s target. In the Eurozone, prices themselves may be an issue and could ultimately hobble growth.
In the US, the economy held up unexpectedly well in 2023, mainly due to its lower sensitivity to interest rates. Many households and businesses were able to lock in their debt at lower interest rates, enabling them to better absorb the impacts of monetary tightening, at least in the short term. Better short-term absorption does not mean that these households and businesses will be unaffected, but it does defer the repressive impact of high interest rates. The amount of corporate debt maturing is increasing in 2024 and will continue to grow in 2025. The impact of rising interest rates on households could also intensify slowly as the effective interest rate gradually rises, while arrears on other types of debt (eg, credit cards and auto loans) have already grown. Higher interest rates will bite eventually, when large amounts of debt have to be financed at higher interest rates, leading to a mild recession in Q424 and Q125. The recession will only be mild, mainly because unemployment is expected to rise only modestly to 4.6%. After 2.5% growth in 2023, our scenario calls for growth of 1.8% in 2024 and just 0.4% in 2025, despite gradual interest rate cuts orchestrated by a cautious Fed. Although it has slowed, inflation remains sticky. Despite an expected mild recession and further fairly robust wage growth, disinflation is expected to continue, But over our forecast horizon (2025), headline and core inflation are expected to fall to around 2.4% and 2.7%, respectively, which is above the 2% target.
In the Eurozone, headline inflation has come down (from an average annual rate of 5.5% in 2023 to an expected 2.6% in 2024 and 2.1% in 2025), and improved financing conditions are fuelling hopes of a recovery in domestic private-sector spending, in particular household consumption. As a result, our scenario is cautiously optimistic, and we are forecasting GDP growth of 0.7% in 2024 and 1.5% in 2025 (after growth of 0.5% in 2023). The short-term outlook has brightened somewhat, but doubts over the longer term persist, including unanswered questions about the potential growth in this new interest rate and inflation regime, and whether or not this new monetary normal is here to stay. Furthermore, the negative competitiveness shock associated with the war in Ukraine could have damaged the zone’s growth potential on a more permanent basis. The downside risks to growth are greater than the upside inflation risks.
In China – which has no major recovery plan despite some ambitious official targets – our scenario remains cautious and projects that growth will fall from 5.2% in 2023 to 4.4% in 2024, which is barely an improvement on the 2022-23 average of 4.1%. China’s easing measures mean that the best we can hope for is a modest slowdown and very muted reflation, given the persistence of disinflationary pressure associated with weak consumer demand, the absence of measures to stimulate consumer spending, and saturation in certain manufacturing sectors.
Do not trip up when it comes to monetary policy. Slow and steady wins the race. Inflation has come down from extremely high levels, albeit unevenly, and has suffered shocks along the way (especially in the Eurozone). Central banks hiked their key rates to rein in inflation, and they have remained high for some time now. It is time to start cutting rates cautiously.
The Fed has been extremely vigilant and could start to cautiously ease its monetary policy with an initial 25bp cut to its key rate in July. Another 25bp cut in November would bring the upper bound of the Fed funds rate down to 5.00% by year-end. Based on the sharper slowdown in growth in our scenario for early 2025, we then expect the Fed to pick up the pace of its rate cuts and bring the upper bound down to 3.50%. With inflation expected to remain stubbornly above the Fed’s target and the neutral interest rate likely to be higher than before, the Fed may have a tough time bringing the upper bound down further than 3.50%.
Meanwhile, the ECB should be able to start easing monetary policy in June given the improvement in inflation. The ECB is expected to cut rates by 75bp in 2024 and the same amount in 2025, bringing the deposit facility rate to 2.50%.
When it comes to bond yields, do not hope for too much. While markets were developing a scenario of imminent and widespread key rate cuts, solid growth and sticky inflation caused them to become disillusioned: long rates have risen. But expectations for monetary easing still seem too optimistic. Long rates may have to wait a little longer before embarking on a gradual downward trend.
In the US scenario, yields are slightly higher across the curve. To illustrate this, US Treasury yields are expected to be around 4.20% at year-end, compared to the previous forecast of 4.10%.
In the Eurozone, the upward adjustment implied by excessively optimistic expectations for monetary easing, the absence of a recession but also the budget deficits of several major countries, mean that we should not expect yields on European government bonds to fall significantly. The 10Y Bund yield is expected to be around 2.40% at the end of 2024. Sovereign spreads are not expected to suffer, assuming that the key factors keeping them narrower remain (easier financial conditions and lower volatility, pushing investors to be less risk-averse). With monetary easing set to begin, our scenario calls for spreads to widen very modestly, with France and Italy respectively offering premiums of approximately 60bp and 160bp over the Bund at the end of 2024.
Finally, on FX, the 2024 calendar is full enough for us to concentrate on this year alone before outlining a longer-term scenario. Monetary easing is around the corner, and there is the prospect of a mild recession in the US, where a presidential election will be held in November. The combination of these factors means that we are calling for the USD to underperform slightly against its G10 peers (except for the EUR) before recovering in Q4.
China: confidence, price war and credibility are the watchwords in this early part of the year
After a break in the statistics as a result of the Chinese New Year, economic activity data for January and February was published last week. While some numbers surprised to the upside, starting with industrial production (up 7% year on year), buoyed by external demand (with exports up 5.6% in January and 8.2% in February), China remains in the grip of structural difficulties, particular in the real estate sector.
Confidence, or rather a lack thereof, is reflected throughout the economy: in retail sales (up 5.5% year on year in February, falling short of the consensus), private investment, imports (down 8.2% in February) and, above all, real estate indicators. Real estate is the main focus of concern: far from improving, key variables like housing starts, square footage sold and new construction have all deteriorated further in the early part of this year. With nearly half of all developers insolvent, the weakened real estate sector remains stuck in the first phase of its slow transformation: finishing projects already in progress and paid for that still offer a degree of profitability.
While the number of new construction projects has fallen 60% from its 2019 peak, average prices in major cities adjusted by a mere 6.3% in 2023. While this figure masks disparities between megacities that remain subject to strong demographic pressure (Beijing, Shanghai and Shenzhen) and other cities, it is indicative of the fact that the authorities are keen to regulate how far prices can fall, for three reasons:
A price war is raging in the electric vehicle market. Battery maker BYD, now a giant in China’s automotive industry, is on the rampage. In 2023, it replaced Tesla as the world’s leading EV manufacturer, making China the leading exporter of cars, ahead of Japan and Germany. Since the start of this year, BYD, which is financially stronger than most of its competitors, has cut prices on its entry-level models even further, with basic models now starting at under US$10,000.
This price war is dangerous. Of course, it helps consumers in the short term by stimulating competition. But with the Chinese economy already struggling with very low or even negative inflation, it comes at a time when domestic demand is weak. While inflation finally returned to positive territory in February (coming in at 0.8% year on year), this was mainly down to a favourable base effect and the Chinese New Year, which tends to give prices a boost in sectors linked to the festivities (transport, hotels, catering, etc.).
In the automotive sector, two conditions must be met before a price war can happen: the authorities must provide high levels of subsidies (both directly to manufacturers – for example for research and development – and to buyers) and manufacturers’ margins must come down. Because they are targeting export markets, particularly in Europe, where they can charge higher prices while remaining competitive relative to American and European brands, automotive manufacturers are willing to accept a short-term squeeze on their margins.
But the European Union appears increasingly reluctant to throw open the single market to Chinese EVs, despite the fact that European consumers could benefit from lower prices and such a move would push up EV penetration compared to that of dirtier combustion engine vehicles. The Commission has thus kicked off an investigation to establish just what level of state subsidies Chinese EV makers are receiving, the idea being to use this argument to condemn unfair competition and put in place further tariff and non-tariff barriers.
Such an offensive would be very bad news for the Chinese economy, which is more reliant than ever on its manufacturing industry, particularly the “new three” (electric vehicles, solar panels and batteries), to maintain its industrial capability and sell off surplus production that cannot be absorbed by a sluggish domestic market. In February, the cumulative 12-month trade surplus reached a new record, coming in well above $1 trillion (at $1.096 trillion).
Until the Covid crisis came along, this was China’s great strength. These past four years, though, what markets expect and what the authorities want seem to have been out of alignment. Markets were disappointed first by the shakiness of the recovery in early 2023 and second by what they saw as inadequate fiscal stimulus from the government. As a result, certain decisions (e.g. to support equity markets, which were beginning to fall too fast) were hastily announced, serving only to further stoke fears over the real state of the economy.
Total stimulus measures over the last three years have been far from derisory, though they pale into insignificance compared with the huge stimulus campaigns of 2008 and 2015. However, they have failed to convince investors and consumers, and it is perhaps this that marks the starkest contrast with the past and China’s remarkable ability to find the right levers to revive the economic cycle.
If you look closely, however, what the authorities are saying is consistent with what they are doing: prioritising not only political stability and deleveraging – particularly in local government, responsible for much excess in this regard – but also the role of central government, the public sector and, above all, the Party at the centre of China’s economic life. Perhaps the problem lies in markets’ refusal to accept this change.