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Kristen Hallam

Ken, before we get to the 2024 predictions, could we briefly revisit our 2023 predictions? How did we do overall on those?

Ken Wattret

Well, I'm pleased to say we did quite well. Several predictions came to fruition. One of those was an expectation that supply chain disruptions would ease and in turn, that would contribute to much lower inflation rates, which we saw. We also predicted that the services subcomponents of inflation would be relatively sticky, related in part to a prediction of continued shortages of labor.

And linked to that, we predicted that monetary policy tightening would continue in 2023 in advanced economies, which it did. In fact, the hiking cycles actually went a bit further than we'd expected. In contrast, we correctly forecast relatively early starts to Central Bank rate cuts in Latin America and emerging Europe.

With regard to growth, we expected that Asia Pacific would remain relatively resilient in 2023, which it did despite predicting at the same time, a difficult year for China's economy, which it was. We also correctly predicted that Western Europe would fall into recession, although it did take a bit longer to get there than we had expected.

We were less successful with our prediction of a recession in the U.S. And related to that, we were also wrong footed on the U.S. dollar, which proved to be more resilient than we had forecast. Long story short, we had several hits, also a few misses, and we try to learn from those misses when setting our predictions for this year.

Kristen Hallam

Well, that sounds pretty good overall, considering all the economic challenges we saw in 2023. So let's pivot to 2024. Ken, you mentioned the gradual return to central bank inflation targets that we saw in 2023. Is that still what we expect for 2024?

Ken Wattret

We do expect consumer price inflation rates to continue to fall in 2024 as supply and demand continue to rebalance, although in some advanced economies, we're not expecting Central Bank inflation targets to be achieved sustainably until 2025. And that's because achieving those targets is likely to require an easing of labor market conditions and lower wage and unit labor cost increases and those 2 factors take some time to materialize.

Wage growth rates are generally topping out, but the lags in that process can be rather long. We also need to keep an eye on various risks to our inflation forecasts. One is commodity price trends becoming less of a disinflationary force, the materials price index, which is compiled by our colleagues in pricing and purchasing that troughed in the middle of 2023, and that's expected to rise gradually this year and also in 2025.

And there are also some factors as well, which we need to monitor in other areas, higher-than-expected food inflation, for example, due to weather-related issues, including El Niño, that's another risk. But the bottom line is we're expecting that the improvement in consumer price inflation that we saw last year will continue this year.

Kristen Hallam

So given expectations of slowing but still above target inflation at advanced economies, what do we think that means for growth prospects this year?

Ken Wattret

Well, we think growth prospects look challenging in many parts of the world, including in North America and Western Europe, where we're forecasting below potential annual real GDP growth rates this year. Consistent with the goal I mentioned earlier of bringing inflation rates sustainably back to target.

To give you some numbers in the euro area, for example, we're forecasting annual real GDP growth of around 0.5%, very insipid growth with various headwinds expected to continue to weigh on economic activity, including like pretty much everywhere, the lagged effect of tighter financial conditions.

There are some variations in the expectations of growth within the region, the more industry-sensitive economies in Europe, including the biggest, Germany, they're expected to continue to struggle. Further south, we had a boost from pent-up demand for services, which benefited the tourism sensitive countries in 2023, but that pent-up demand has already faded so they're also expected to lose growth momentum this year. The UK is also forecasted to perform quite poorly. We're expecting a real GDP contraction annually in 2024 with various headwinds, including difficulties in the household sector continuing to weigh. Somewhat more positively in the U.S., we're expecting annual growth of around 1.5% this year.

That's below trend, but a little better than what we're expecting in most of Europe. In part, that reflects some carryover effects from strength in the U.S. economy in the autumn of last year, but it's also reflecting some of the factors, including supportive fiscal policy. Again, that paint a contrast to what's happening in Europe.

Looking further afield, we expect to see relative strength in some of the regions, including Asia Pacific, in particular. That's expected to help global hard landing within the APAC region, we're expecting continued robust expansions in several of the larger economies, including India and Indonesia.

And another region where we expect relatively brisk growth is sub-Saharan Africa, although its share of global GDP is much lower than that for APAC. So it has less global resonance. The bottom line is we think from a global perspective, real GDP will grow annually by a little over 2% this year, but that's below estimates of the potential rate and it's below 2023's projected growth rate, which is a little below 3%.

Kristen Hallam

And what about Mainland China's growth in particular? You mentioned earlier that in 2023, the growth there was a bit disappointing. What about in 2024?

Ken Wattret

Well, we're expecting the economy will continue to recover rather gradually. We're expecting annual real GDP growth this year in the region of 4.5% to 4.75%. The economy is basically struggling against various cyclical and structural challenges, including problems in the real estate sector, high levels of corporate debt and so on.

And that makes a return to the sustained high growth rates of the past rather unlikely. Now having said that, we expect growth this year to be supported by a few factors, including a more accommodative policy, both monetary and fiscal a gradual improvement of private sector confidence. And also, we're expecting the difficulties in the housing market to start to diminish.

The aspect I would highlight from those factors is the policy stimulus. The government has markedly stepped up its fiscal support in recent months, and that sends a pretty strong signal of its determination to try and support the economic recovery and it's a recognition, I think, of the difficulties China had in gaining growth momentum last year.

Kristen Hallam

Now given the outlook on growth and inflation that you've described, how do we expect central banks to respond? And in keeping with our economic fault lines theme, will we see a difference in how central banks and advanced economies respond compared with emerging economies?

Ken Wattret

Well, we're very confident in the prediction that we'll see a series of interest rate cuts across advanced economies during 2024, given the backdrop of subdued economic growth and moderating inflation. The uncertainty really, I think, relates to the timing and magnitude rather than the direction. And we have seen financial market expectations of policy rate reductions shift a lot recently.

For example, the current expectation is for around 150 basis points of policy rate cuts in the U.S. and Eurozone in total this year. That looks somewhat overdone in our view. On the positive side, recent U.S. inflation data have been more favorable, and labor market conditions have shown signs of easing. There are 2 preconditions for the Federal Reserve to be thinking about cutting interest rates.

And consistent with those developments, we're expecting 100 basis points of Fed rate cuts this year. And the likelihood of the easing cycle starting in the spring has risen given those developments. With regard to the ECB, market surprising a lot of rate cuts quite quickly. 325 basis point rate cuts are pretty much priced in as soon as June.

That's too much, in our view, given still elevated wage and unit labor cost increases, we see Q2 as a more realistic timetable for an initial cut in rates. And we're expecting, again, a total of 100 basis points of cuts during the year as a whole. Great expectations in financial markets in the UK have been a bit less exuberant, reflecting the more challenging inflation situation here.

Still, we have over 100 basis points of cuts by the Bank of England priced in by futures markets already beginning in May. That looks a little premature. In our view, our forecast is that the first breakup will occur a little later, probably in August and for less easing overall given comparatively sticky inflation rates and quite high wage growth in the UK.

We should also highlight that the Bank of Japan, notably is heading in a different direction. We're expecting an end to its negative short-term interest rates in the spring of this year. That, in turn, is expected to continue to support the Yen. And as you mentioned, it's been a different story for some emerging economies.

When usually, we've seen many central banks in Latin America and emerging Europe, lowering their policy rates late last year, while the Fed maintained a tightening bias. That's not a normal course of events. Big picture wise, that the central banks already cutting rates generally tightened monetary policy early and forcefully in response to soaring inflation rates back in 2021.

That allows the rate cuts to materialize earlier on the way down. And we're expecting more emerging market central banks to join in this easing before long. Those rate cuts that we've seen in those 2 regions are likely to become more widespread during the first half of this year as inflation prospects continue to improve.

Kristen Hallam

That takes us through our top 5 predictions, which I'll just quickly recap for our listeners. So number one was inflation will moderate further. Number two is growth in North America and Western Europe will fall short of its potential. Number three is that Mainland and China's economy will recover slowly. Number four is policy rate cuts will begin in the U.S. and Western Europe during the first half of 2024.

And number five is emerging markets will get an earlier start on easing cycles. So that takes us to our prediction that the U.S. dollar will depreciate, which dovetails with the expected slowing of U.S. growth and inflation. Our next prediction is that financial headwinds to growth will persist. Ken, tell us more about what we're expecting to see there.

Ken Wattret

Well, if we start with the U.S. dollar, it's already lost some ground. We expect this to continue through 2024 in large part due to a shift in interest rate differentials. Looking back to last year, treasury yields in the U.S. were elevated relative to government bond yields in other advanced economies, but that's now reversing as expectations of lower Fed policy rates build.

Add to that slower U.S. growth and the unsustainably large U.S. current account deficit and most factors point to a continued depreciation, including the fact that the dollar has been relatively strong for quite a long time already. Switching to the financial headwinds. Again, it's to do with the lagged impact of higher interest rates, plus also the waning effect of COVID-related support measures.

Those 2 factors suggest that nonperforming loans are going to rise across most regions. And the load banks are pretty well provisioned against additional loan losses, and we're not anticipating a wave of financial crisis. Banks are likely to maintain quite a cautious stance towards lending. And those tight credit conditions in many countries will act as an additional headwind to economic growth.

Kristen Hallam

And then our eighth prediction is that declines in house prices in Western Europe have further to go due in part to tighter credit conditions. Our ninth prediction is that a busy electoral calendar will generate policy uncertainty. It is busy. I think there are over 70 elections scheduled in 2024. What kind of impact do we expect that to have on growth, Ken?

Ken Wattret

Well actually, both of these factors are unfavorable from a growth perspective. Thinking about house prices, we've seen falls in residential house prices across most of Western Europe over the past year or so. And again, same factor, the lagged effect of higher interest rates. The downward pressure takes time to come through, and that's why we expect these declines generally have further to go.

Now that has an impact on construction activity, a negative impact, and in turn, holds back investment growth, but it also hits consumer spending too via negative wealth effects. There is a silver lining in the cloud, both inside and outside of Europe, which is that there are supply shortages in many residential housing markets.

And they are either boosting prices or limiting the scale of the declines we're seeing. And as you'll recall, there was a huge excess of supply, which contributed to collapsing house prices during the global financial crisis. Thankfully, the circumstances are different this time around. So we're not expecting the same degree of declines in prices or spillover effects into the financial sector.

With regard to the political landscape, as you mentioned, it's packed with elections and the key issue there for economic prospect is uncertainty, nowhere more so actually than in the U.S. Now of course, the U.S. presidential election will take place rather late in the year in November. So one would expect the changes in economic policy would have more of an impact for 2025.

Now that's true, but uncertainty about the outcome of this election and its policy implications could be a hindrance to economic growth during what is typically a very drawn-out election campaign. And that's not just an issue for the U.S. It's also an issue potentially internationally, too, given the possible impact of the election on international relations, including concerns related to the imposition of tariffs.

So we know that issue of uncertainty, I think, is likely to be with us for quite some time. I should also add on the political front, to be clear that our economic forecasts are predicated on no major escalation in the current conflict in Ukraine and the Middle East.

Kristen Hallam

Yes, important to note that there. And I will encourage our listeners to check out our previous podcast episode if they haven't already on our 2024 themes where we go into a bit more depth on the elections and the uncertainty related to those.

So last but not least, prediction number 10. We're predicting that the energy transition will support growth in the U.S. and Canada. Ken, what specifically is driving that? Is it the Inflation Reduction Act in the U.S.? Are there other factors at play here?

Ken Wattret

It's largely the policy initiatives that have been introduced in the U.S, they've been having a direct impact on economic activity in some areas. Subsidies for green energy projects, for example, have led to a huge increase in the construction of electrical manufacturing and related facilities and the chip sector has also been boosting production of U.S. fabrication plants.

So this is one of a few factors which lean against the U.S. economy going into recession, including, as I was mentioning the expectation of interest rate reductions. And elsewhere in North America and Canada too, we've seen various climate initiatives introduced and they're expected to contribute to nonresidential investment being a key driver of real GDP growth in 2024 and also beyond.

I don't want to overplay the outlook for growth in North America for 2024. We are expecting slowdowns, but it looks as if the likelihood of North America following Western Europe into recession is diminished in part by these various energy-related initiatives.

Kristen Hallam

Interesting. That sounds like a future podcast episode right there. So all that's left for me to do is to thank you Ken, for sharing your insights with us. And thanks to you, our listeners for tuning in. As I mentioned in the intro, economic fault lines is 1 of 5 themes we'll be watching. The others are geopolitical reordering, resource security, supply chain resilience and logistics rewired.

If you'd like a copy of our 2024 themes report, please use the link in the description of this episode. I'll also include a link to our blog post on our 2024 economic predictions. Please join us next week when we'll be exploring the theme of geopolitical reordering.

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