Chart 1

Strong Rebound But Short Lived

A slowdown in demand is likely in Europe and North America after a buoyant year so far, while China returns to its 2019 sales volumes.  Global demand for light vehicles unexpectedly surged 8% in the first half of 2023, largely outperforming our earlier 3%-5% forecast for 2023. As a result, we have revised upward our full-year 2023 base-case forecasts. Momentum was strongest in Europe (+17%) and in North America (+13%), despite high inflation, rising interest rates, and the Russia-Ukraine conflict.

We think this surge came from the release of pent-up demand linked to the easing of supply constraints this year. For 2024 and 2025, we continue to expect very gradual recovery of volumes as demand aligns with subpar global economic growth resulting from higher-for-longer rates ahead. In our base case, only China is largely back to pre-pandemic levels in terms of sales this year, despite weakness of domestic consumption. China's increasing gap between sales and production over 2023-2025 reflects its growing status as a net global exporter of light vehicles. In Europe and the U.S., sales will rise moderately after the surge in 2023, failing to recover to pre-pandemic levels even by 2025. We expect global production will remain tightly linked to demand as automakers stay disciplined on inventory buildup, given that a pronounced downturn in the labor market in North America and the eurozone could push the global economy into recession. The underlying macroeconomic scenario remains largely unchanged from our previous forecast (see "Global Economic Outlook Q4 2023: Nearing The Rate Plateau," published Sept. 27, 2023).

Table 1

Fleet demand normalization could highlight retail softness in Europe and North America.   In Europe, the breakdown of sales by ownership shows that private sales account for just 40% of the total (S&P Global Mobility). The remainder of sales were mainly to corporates, rental companies, and governments, i.e. "fleet managers." Since 2020, not only have private sales fallen below the 40% threshold (38% in third-quarter 2023), but this bucket, already down 12% in 2022, is further declining--36% year on year in third-quarter 2023. We believe that the change in macroeconomic fundamentals started to depress private demand already last year and that the fleet component (less directly exposed to failing purchasing power), held back so far by supply constraints, had a key role in driving volumes in 2022 and in the first half of 2023. As the purchasing cycle of fleet buyers normalizes, we expect the weakness of the private component to more clearly emerge from 2024, limiting the potential recovery of light vehicle demand to about 17 million units by 2025 (down from 20 million in 2019). We expect a similar trend in the U.S., as the share of rental car and commercial fleets normalizes after returning to pre-pandemic levels this year (roughly 20% of light vehicle sales).

The slowdown in China sales is in line with our expectations, but production remains resilient due to exports.  We correctly anticipated the slowdown in the Chinese auto markets during 2023, mainly due to the distortions caused by auto demand being partially pulled forward to 2022 by stimulus policies (central government's restoration of the full purchase tax on internal combustion engine [ICE] vehicles, and the removal of the electric vehicle [EV] purchase subsidy from January 2023). In the meantime, the cautiously optimistic outlook for China has turned, and we revised down our China GDP forecast for 2023 and 2024 to 4.8% and 4.4%, respectively, to reflect the impact of dipping household and business confidence. Accordingly, we expect auto sales to post very moderate growth in the next two years and China to cease driving global growth of auto industry sales. The outlook on production remains slightly more optimistic though: despite the bleak domestic outlook, China's auto exports are rising substantially and will continue to widen the gap between production and sales, benefiting from a recognized cost advantage and increasing product competitiveness.

Pricing pressure will intensify across regions.   Pricing patterns differ substantially among regions, depending on the structure of local markets combined with the strategy of disruptors and new entrants. Overall, we expect a weaker pricing environment in 2024 and 2025 compared with recent trends for new and used cars. China will continue to be a challenging pricing spot for the next two years for both domestic and international manufacturers and suppliers. In the export market, however, Chinese players, including BYD and SAIC, appear unlikely to trigger a price war and retain stronger profit margins on low but increasing volumes in Europe, for EVs in particular. In the eurozone, pricing trends remain positive so far (Source: Eurostat Eurozone Car Price Index) despite a clear inflexion of the trend, which is more pronounced for second-hand cars but also affects new cars. The average manufacturer's suggested retail price for passenger cars has steadily risen since 2019 (+40%) and is at an all-time high in Europe. New vehicle prices remain about 30% above pre-pandemic levels in the U.S. so far in 2023 (average transaction prices over $45,000 in August according to J.D. Power), but we expect about a 10% decline over the next 24 months in the U.S. as used vehicle prices fall (with potentially higher supply) and product mix trends toward lower-trim versions and more entry-level segments.

A flattish demand environment amid pricing headwinds and strike-related cost increases will limit margin improvement for several U.S auto issuers.  Like in Europe, sales in the U.S. will outpace our previous growth forecast for 2023, with light vehicle volumes up to 9%-10%, versus 5%-7% previously. In our revised scenario, however, 2024 sales will lose steam as we see light vehicle sales stuck at about 15.2 million units (previously 5%-7%, but revised to flat in June 2023). This scenario results mainly from expectations of weakening demand as the economy remains overheated, leaving the door open to further tightening of interest rates. For now, our base case assumes only a modest impact from unrecovered sales in the fourth quarter, due to an extended impact on production from the United Auto Workers (UAW) strike and the supply chain problems. Moreover, once production eventually resumes, we expect a reasonably quick recovery in liquidity over their minimum operating levels, albeit with permanently lost earnings due to lost production. Labor-related cost increases for automakers will heighten our focus on automaker cost management. Margin upside may be limited for suppliers in a flattish demand environment (for the likely impact on ratings and margins, refer to "Credit FAQ: How Will The United Auto Workers' Strike Impact Ratings In The U.S. Auto Sector?," published Sept. 15, 2023).

Electrification: The Frontier Of The New Protectionism?

So far, electrification is progressing at double-digit growth rates in all the three major regions, albeit with early signs of slowing momentum in the U.S. Based on EV volumes, China leads with an EV penetration rate at 30% (21% for battery electric vehicles (BEV] only) for the 12 months ended August 2023. Europe's top 10 EV markets have penetration of 23% (15% BEV only) and the U.S. 9% (7% BEV only).

Chart 2

Sustained EV momentum in Europe, but the picture is scattered.  In the first eight months of 2023, EV represented almost 23% of the new car registrations in Europe (eurozone, European Free Trade Association, and the U.K.), up from slightly less than 20% a year earlier, according to the European Automobile Manufacturers' Association. Our scenario of a rise to more than 30% in 2025 (table 2) still holds, despite downside risks linked to diminished purchasing power and high interest rates. The momentum in the adoption rate of EVs in Europe hides strong differences between countries, with Norway and Sweden leading the green transition (EV penetration rates in excess of 30% already), while Italy and Spain lag dramatically (in the 8%-10% range). Our scenario of more than 30% penetration in 2025 remains consistent with the targeted mix by automakers in Europe, but clearly depends on the resilience of demand in large markets, like Germany, France, and the U.K., to an economic slowdown. In the passenger car space, new BEV rollouts in 2024 in Europe include Ford Puma (SUV-B), Citroen C3 Aircross (SUV-B), Cupra Tavascan (SUV-C) and Peugeot e-408 (car-D) (source: EV Volumes). The competition with imported EVs from China is set to rise. Between now and 2024, the European BEV market will be flooded with new launches by Chinese manufacturers, mainly BYD, Geely (excluding Volvo and Polestar brand), NIO, SAIC, and Aiways. Concerns over China's dominance in electric vehicles led the European Commission to announce an enquiry on Chinese subsidies of electric cars, which could lead to trade restrictions. The initiative is a response to European automakers' concerns about unfair competition, given government support offered to competitors in China and the U.S., Europe has suffered a structural downsizing of its production capacity since the pandemic, losing some 4 million units per year that were transferred closer to end markets. While it's too early to assess the impact of potential measures, we understand the French government is considering in the meantime considerably tightening access to battery vehicles incentives. The latter could be subject to carbon footprint measured over the lifecycle of the vehicle including the upstream (input materials) and the downstream (scrappage and reuse of parts). The revised eligibility criteria could penalize vehicles that are not produced or assembled in the region. This could potentially lead to the exclusion of some vehicles from access to incentives in Europe and bridge the unfavorable pricing gap versus imported vehicles from China.

The sales momentum of new energy vehicles in China remains solid, albeit clearly down from its peak.   EV penetration in China exceeds 30%, well above the original government target of 20% set for 2025. At this level of adoption, incentives from local governments are no longer the most important factor supporting the growth of the EV market. With local producers upgrading product offerings and foreign manufacturers (other than Tesla) trying to catch up in the EV race, competitive pressure is likely to remain strong and weigh on producers' pricing power.

Early signs of slowing momentum in U.S. EV demand leads to a slight downward revision in our 2025 base case.   In the past quarter, we have seen a slight slowdown in market share gains for EVs in the U.S., with rising inventories for several models. As a result, we expect automakers will take a more measured approach on volume build out in 2024 to avoid pricing wars with incumbents for upcoming launches. With manufacturer subsidies from the IRA and investments in local supply chains, and tax credits, we still expect significant launches at more affordable price points through 2025. Together, these factors should help bridge the volume gap with Europe and China. Our estimate for the combined market share of EVs and plug-in hybrids is about 10% for 2023 and about 18% by 2025.

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• Industry Top Trends Update North America: Autos, July 18, 2023
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