Macro Radar

Taking the pulse of economic activity

The danger of a recession in Europe has abated in recent weeks. All of a sudden the glass is half-full again – business sentiment and consumer confidence have brightened. However, the year 2023 will present a challenge for central banks. There is an elevated risk of monetary-policy mistakes.

Prospects have brightened

The outlook for the European economy has brightened lately. Economic activity in China has regained momentum since the rollback of the country’s zeroCOVID policy. This is likely to spark a near-term growth spurt there that will also radiate to Europe. The long stretch of mild winter temperatures and the steep drop in the price of natural gas have likewise boosted sentiment. Economic growth forecasts for the Eurozone have thus recently been revised upward. The Eurozone purchasing managers’ index rose to 50.2 points in January, climbing back above the 50 threshold that signifies expansion. Consumer sentiment likewise has rebounded from its nosedive last autumn. A recession in Europe may even not materialize at all or is at least likely to turn out very mild.

ECB hawks are in the majority

The improved economic activity outlook gives the European Central Bank (ECB) another argument besides rampant inflation for ratcheting the interest-rate level in the Eurozone higher. After raising its marginal lending rate for main refinancing operations to 3.00% in early January, the ECB looks set to implement another 50-basis-point hike in March, but will probably slow its rate-hiking pace afterwards. Before long, the ECB will thus be heading into very restrictive monetary-policy territory well above the Eurozone’s potential rate of growth. In this realm, dangers to growth and to overindebted countries mount, as does the risk of a policy error that soon needs to be corrected.

US Federal Reserve going slower now

The Fed currently finds itself confronted with contradictory data. The US employment market is still robust on the surface, but various recession indicators like the US yield curve and the Conference Board Leading Economic Index that have a consistent track record of being very reliable have dimmed further lately. Inflation, in the meantime, is tending to recede more quickly than expected and could continue to surprise on the downside in the months ahead. The delayed effects of the massive rate-hiking in 2022 also have to be taken into consideration. Growth in the money supply has recently ground to a halt (see chart below). Against this backdrop, the Fed undertook only a small 25-basis-point rate hike in early February. The macro data in the weeks ahead will reveal whether that already marks the end of the line for the federal funds target rate.