Our Chief Europe Economist explains why the region’s outlook over
the next year is trending upward, including how higher growth
will lead to lower interest rates this cycle.
----- Transcript -----
Welcome to Thoughts on the Market. I’m Jens Eisenschmidt, Morgan
Stanley’s Chief Europe Economist. Along with my colleagues
bringing you a variety of perspectives, today I will discuss our
outlook for Europe’s economy in the second half of 2024 and into
next year.
It’s Thursday, May 30 at 10am in Frankfurt.
So, over the last year, we have had a relatively downbeat outlook
for Europe's economy, but as we head into the second half of this
year our view is decidedly more optimistic. After bottoming last
year, euro area growth should reach 0.7 per cent annualized terms
in 2024 and 1.2 per cent in 2025 on the back of stronger
consumption and exports. Inflation is on its way to the European
Central Bank’s target, paving the way for the ECB to start
cutting rates in June with three cuts in 2024, for a total of 75
basis points, and four more cuts in 2025, for a total of 100
basis points.
What’s particularly notable, though, is the set-up of this growth
rebound is highly unusual for several reasons.
Let's start with inflation. In a normal environment, higher
growth leads to higher inflation and vice versa. This time is
different. The euro area needs to grow faster to get inflation
down. The reason is that faster growth should lead to better
resource utilization in sectors characterized by labor hoarding
or keeping a surplus of employees. This should keep unit labor
costs – or how much a business pays its workers to produce one
unit of output – in check. We’re expecting further wage
increases, mostly driven by the catch-up with past inflation, and
so higher productivity is a way to cushion the pass-through to
prices.
So again, just to repeat, we are in a cycle where we need higher
growth to get inflation down and not as usual, we have higher
growth and that gets us more inflation. Of course, there is a
limit to that. If we get too much growth, that would be an issue
potentially for the ECB. And if you get too little growth, that
is another issue because then we won't get the productivity
rebound.
In some sense, you could think of the growth we need as a landing
strip and we need to come in at that landing strip precisely; and
so far, the signs are there that is exactly the picture we are
getting in 2024 and 2025 in Europe.
Now the monetary and fiscal policy mix is another area where this
cycle stands out. So normally, monetary policy would tighten into
an upswing and ease into a downturn, while fiscal policy would be
expansionary in a downturn and contractionary in an upswing. Euro
area monetary policy is currently restrictive – but it’s set to
get less restrictive over time. The likelihood of rates coming
down is hardly bad news for growth. But policymakers will need to
take care to not reignite inflation in the process.
So all of that gives rise to the gradualism that the European
Central Bank has been signaling it will use in its policy easing
approach. And again, think about the landing strip metaphor. If
we are not gradual enough and we reignite a growth too
much, and with it inflation, we might be exiting the landing
strip in one way or the other.
Thanks for listening. If you enjoy the show, please leave us a
review wherever you listen and share Thoughts on the Market with
a friend or colleague today.
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