Inflation globally peaked towards the end of 2022, has decelerated since, and will likely ease further over the first half of 2024. While this should allow central banks in the US, UK and euro area to ease monetary policy, it is still unclear where inflation will settle, as core inflation has been persistent. Some of the global influences that drove inflation down this century have now been dampened: globalisation has been supplanted by fragmentation, and the squeeze on wage shares in western economies has been eased, although that is a welcome aspect.
Thus, the prospect of future inflation settling nearer 3% than 1-2% in western economies may limit the ability of central banks to ease aggressively. When inflation rose sharply in the 70s or eased in the early 90s markets mistakenly expected it to return to previous levels; that remains a possibility now.
‘Disinflation will be the buzzword for markets’ was our view in August. While the subsequent data justified this claim – showing slowing growth and easing inflation pressures – it was not how the major central banks in the west saw it, hiking further.
Now, a soft landing or disinflation is the view of US markets. In contrast, the UK and Western Europe, are in a far weaker position, not helped by the further tightening seen in recent months. The euro area is likely to finish 2023 in a technical recession, with successive negative quarters of GDP, and the UK stagnating. The UK economy has not recovered fully from the 2008 global financial crisis (GFC) and its public finances have yet to recover fully from the pandemic. Policy stimulus will be needed in 2024 to allow the UK and euro area to achieve modest growth.
The IMF’s early new year growth forecast will be an important guide. In October they forecast global growth of 3% in 2023 being followed by 2.9% in 2024. This is very weak. Early 2024 looks difficult for growth, globally.
At times of uncertainty it is always worth noting the strategic, longer-term trends at play. Foremost among those is the ongoing shift in the balance of global economic power, to the Indo Pacific – stretching from India to the US.
Within this region, China’s future trend rate of growth is likely to be lower and more volatile. The markets began the past year too pessimistic about the west, expecting imminent recession, and too optimistic about China. Now, expectations seem too pessimistic about China. But it should achieve growth around 4%. India, meanwhile, is benefiting from sizeable inward investment as its catch-up potential is huge; it should be the global growth leader in 2024. Meanwhile, US growth looks set to outstrip the UK and Western Europe.
The big issue for markets in recent years has been the end of cheap money. That led, among other things, to a bear market for bonds. Now, and in 2024, the story is monetary easing. Emerging economies are easing already – many had adopted more prudent policies. In western economies, rates now need to fall, an issue we focused on last week. Powell’s better communication in the US allows the Fed some agility to change tack without a loss of face.
Many of the issues we have highlighted on monetary policy in recent years have come to the fore. Policy was too loose, and did not tighten early enough, contributing to inflation. Central banks in the west misdiagnosed inflation.
Then, in the summer I wrote that rates needed to stay higher for longer. Following that, in my view I felt western central banks had tightened too much. Higher for longer didn’t mean to push rates as high as you can. Interest rate hiking should have paused some time ago, for instance, probably around 4.5% in the UK, as opposed to rates now of 5.25%.
Rates in the US, UK and euro area need to fall in 2024. I do not see this as being inconsistent with rates being higher for longer as my view is rates will need to stabilise at higher levels in the future, as we enter 2025, than pre-pandemic, but not stabilise at current levels. One of the key debates in 2024 is likely to be where is the future neutral level for policy rates? The focus may be on 3% to 4%, as opposed to previously lower levels.
If that is the case then in twelve months it may be that the focus for markets will switch from growth to debt. For while debt to GDP ratios will improve with some inflation, the combination of high levels of debt and of policy rates and yields settling at above economic growth rates will pose challenges.
Finally, geopolitical tensions look set to persist, and 2024 will also be an important election year. An important global development is the emergence of a G3 world: group one, the US and allies; group two, led by China; group three the non-aligned group that includes powers like India and Nigeria. This latter group is referred to as hedging states in the US and in the UK as Middle Ground Powers.
Global attention will be focused during 2024 on elections. These include: Taiwan; Pakistan and India which head to the polls in the same year for the first time; national elections in South Africa; presidential elections in Indonesia and in Mexico; European Parliamentary elections; the UK whose general election must be held by January 2025; and of course the US elections in November.
We will return early in the new year with our forecasts for 2024. For now, the message here is that the next twelve months could see significant change economically and politically, and the signs already suggest we have reached a turning point in monetary policy.
Please note, the value of your investments can go down as well as up.
