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Global financial markets remain focused on US inflation and the outlook for interest rates

Despite sustained high interest rates, the US economy continues to outperform. The GDP growth estimate for 2024 was revised higher and is currently around 2.2%, up from 0.9% just six months ago. Although the upward revision was largely driven by the persistent strength of the US labour market, most parts of the US economy continue to record solid growth.
Global Inflation
Picture of Kevin Lings
Kevin Lings

Chief Economist

It is also important to highlight that, while economic growth in the euro area and China has been relatively disappointing over the past six months, the most recent growth indicators in China have surprised convincingly on the upside. In the euro area, data is generally no longer getting worse, with the manufacturing data showing some signs of improvement. In fact, the global manufacturing PMI has just risen above 50 for the first time since mid-2022, and there are even signs of world trade picking up.


The recent improvement in global manufacturing is likely to be largely due to the rebuilding of inventories, coupled with some increased demand for electronic components in selected industries – and not the start of a sustained broad-based recovery in world trade and industrial production. The recent improvement in a range of economic metrics is adding to the global uncertainty about the outlook for inflation and interest rates.


Inflation data has been disappointing. Although the annual rate of change in global consumer prices is well below the peak recorded in 2022, the recent progress in getting inflation back down to target has stalled, notably on services inflation in the major advanced economies, especially the US. The Federal Reserve is watching to see whether this is a “bump in the road” or more concerning.


With global inflation no longer surprising on the downside, especially in the US, financial markets have rapidly priced out more than half of the rate cuts they had anticipated from the major central banks just three months ago. The net result is increased financial market uncertainty and a bout of weakness in global equities, after a sustained period of significant outperformance.


The US keeps adding jobs at an impressive pace


In March 2024, the US added an incredible 303 000 jobs, which was well above market expectations for an increase of 214 000. It was the largest monthly increase in employment since October 2022. Over the past six months the US has added an average of 244 000 jobs a month, which should allow the economy to keep growing at just over 2%.


Interestingly, most of the employment gains were in the service sectors, including government, which has added an average of 61 000 jobs a month over the past six months. In addition, the healthcare and education sectors have averaged jobs gains of 82 400 a month for the past six months. This means that the government, together with healthcare and education, account for almost 59% of the total US job gains in the past six months.


The ongoing increase in employment has also kept the unemployment rate exceptionally low. In fact, the US unemployment rate has ranged between 3.4% and 3.9% in each of the previous 23 months, which essentially represents full employment.


Unfortunately, the ongoing strength in the US labour market has been accompanied by an upside surprise in US inflation in the first three months of 2024. In March 2024 US consumer inflation rose by a higher-than-expected 0.4% month-on-month, which pushed the annual rate of inflation from 3.2% to 3.5%. The market was expecting inflation to increase by a more modest 0.3% in the month. While a portion of the higher-than-expected increase in inflation can be ascribed, once again, to the cost of vehicle insurance (which is now up 22.2% year-on-year), shelter inflation also remains elevated at 5.7%. A wider range of categories recorded slightly higher-than-expected price increases in March, suggesting some potential broadening out of inflationary pressure which would be very concerning for the US Federal Reserve (Fed).


Although US inflation is expected to slow during 2024, to a little below 3% towards the end of the year, it is unlikely to approach the Fed’s 2% target before the end of 2024 – especially if the oil price remains around the current $90/bl.


Euro area economy should gain momentum in 2024 as inflation decelerates, but risks remain


The euro area economy avoided a technical a recession in 2023 after GDP growth was 0% quarter-on-quarter in the fourth quarter of 2023, following a 0.1% contraction in the previous quarter. Southern European economies were key in helping the euro area to avoid the technical recession, with strong growth from Spain (0.6%), Italy (0.2%) and Portugal (0.8%). In contrast, the euro area’s biggest economy, Germany, remained a significant source of underperformance for the region, contracting by 0.3% in the fourth quarter, weighed down by falling exports and fixed investments.


For 2023, euro area GDP expanded by 0.4%, a significant moderation from 2022’s growth of 3.4%, as high energy prices and tight monetary policy restricted demand.


More positively, some high-frequency economic indicators suggests that the euro area is slowly recovering, with activity picking up pace towards the end of Q1 2024. Unfortunately, the improvement was uneven across industries, highlighting that the economy continues to experience some constraints. For example, the region’s PMI data for March reflected this divergence, with a significant improvement in the services sector while manufacturing activity declined. The services PMI was in expansionary territory for the second consecutive month, rising to an eight-month high. In contrast, manufacturing PMI fell further into contractionary territory, although underlying subcomponents point to more resilience than the headline figure.


Overall, the euro area economy is expected to gradually improve in 2024 as lower inflation and continued wage growth boosts consumption. The strong labour market should also support demand (euro area unemployment was at a record low of 6.5% in February). Unfortunately, significant headwinds are likely to persist in 2024 and could jeopardise the region’s economic recovery. These include prolonged high interest rates; the repeal of fiscal support measures, especially in Germany; potential energy market turmoil; and ongoing geopolitical instability. Euro area GDP is expected to grow by only 0.5% in 2024, before improving to 1.3% in 2025.


Euro area inflation continued to improve, with headline inflation falling to 2.4% year-on-year in March from 2.6% in February. The slowdown in consumer inflation reflected smaller increases in food and goods prices, which offset sticky services prices. Core inflation continued to moderate in March, coming in below 3% for the first time since February 2022, indicating that the underlying disinflationary trend remains on track. This trend is expected to continue in 2024, with headline inflation likely to move close to the 2% target in the second half of the year.


The European Central Bank (ECB) decided to keep its benchmark interest rate unchanged at 4.5% for the fifth consecutive policy meeting in April. However, this time there was an explicit mention of interest rate cuts, suggesting that the ECB may be preparing to cut rates as euro area inflation continues to soften. While it is still cautious about declaring it has fully controlled inflation, the ECB could start cutting interest rates as soon as June, before the US Fed has commenced its own rate cutting cycle.


China is likely to face uneven and fragile economic growth in 2024


China’s GDP grew by 1% quarter-on-quarter in the Q4 2023, lower than the previous quarter’s performance of 1.5%. The economy continues to face ongoing challenges, including a slump in the property market, as well as weak domestic and global demand. In 2023, the government achieved its economic growth target of 5%, helped enormously by favourable base effects – which masked the underlying weakness in the broader economy. The Chinese economy grew by only 3% in 2022, a significant deterioration from the 8.4% growth achieved in 2021.


Encouragingly, recent high frequency data has shown some revival of economic activity in the first quarter of 2024, although the trend remains uneven. In particular, China’s PMI data was surprisingly strong in March, with manufacturing PMI swinging back into expansionary territory for the first time since September 2023, at 50.8 points. Non-manufacturing PMI moved further into expansion, at 53 points, as construction activity continued to accelerate, suggesting that the government’s fiscal stimulus is working.


Industrial production and fixed asset investment growth unexpectedly accelerated in the first two months of the year (growing by 7% and 4.2% respectively) as policy support measures kicked in. Consumption activity during this period, however, was less consistent, with signs of weak domestic demand continuing. For instance, while retail sales beat expectations, growing by 5.5%, this was slower than the 7.4% growth recorded in December, despite strong holiday-related consumption spending around the Lunar New Year. Credit expansion slowed in the first two months of the year.


The Chinese economy is still facing serious headwinds from the real estate sector, which remains a key drag on the economy. Investment in real estate and house price data indicate that the housing market slump is far from over, despite additional government support.


Overall, economic growth is far from resilient. Without the benefit of favourable base effects, China’s GDP growth is expected to miss the government’s 5% target for 2024. The economy is likely to grow by 4.6% in 2024, before moderating to 4.2% in 2025. Concerns about the performance of the Chinese economy remain and the strong momentum in economic activity seen early in the year could stall without more policy support from government.


China’s headline consumer inflation hovered just above zero in March, showing that deflationary pressures are still present after a temporary surge in demand during the Lunar New Year holiday. China’s headline inflation has been below the People’s Bank of China’s (PBoC) implicit target of 3% for an extended period. In addition, core inflation remains weak, having been at or below 1% for 23 of the last 24 months, suggesting that underlying domestic demand remains subdued.


The path to economic recovery for China remains bumpy and the current deflationary risks require more forceful monetary policy action. Positively, the PBoC showed its determination to support growth with an unexpected 0.5 percentage point cut in the Reserve Requirement Ratio to 10% in February, equivalent to releasing Rmb1 trillion in long-term capital into the financial system. In addition, China lowered its five-year prime rate by a larger-than-expected 0.25 percentage points to 3.95%, a move that reduces mortgage rates for homebuyers and aims to support demand in the property sector.


South African economy remains stagnant, but private-public partnerships are gaining traction


The South African economy remains under significant pressure. Most economic sectors are struggling to cope with a combination of ongoing electricity and water outages; declining household disposable income (in real terms); persistent port and rail constraints; sustained high interest rates; and weak consumer and business confidence. Unsurprisingly, in the final quarter of 2023, GDP grew by a mere 0.1% quarter-on-quarter. This compares with a decline of 0.2% in the third quarter and market expectations for growth of 0.2%. For 2023 as a whole, the economy grew by only 0.6%, which is well below the population growth rate. It is SA’s worst annual economic performance since the Covid-induced decline in 2020.


Although SA managed to avoid slipping into a technical recession at the end of 2023, the economy is essentially stagnating. Unemployment remains extremely high at over 30%, the government debt to GDP ratio now exceeds 75% and government’s debt servicing cost is more than 20% of total tax revenue.


Encouragingly, the government continues to make progress on its reform agenda, which has partly focused on initiating private/public partnerships to help alleviate some of the key infrastructural failures. This has included the deregulation of the energy sector to allow private sector investment in renewable energy as well as the release of Transnet’s Network Statement as a precursor to private sector investment in key rail corridors. The more these reforms are allowed to gain traction, the greater the chance of a meaningful uplift in SA’s growth performance. The outcome of the National Election on 29 May 2024 will be critical to ensuring continued policy reform.


In February 2024, SA’s consumer inflation rate rose by a substantial 1% month-on-month, hurt by the higher fuel price as well as a sharp increase (12.9% year-on-year) in the cost of medical insurance. Fortunately, food prices declined by a very welcome -0.1% month-on-month in March, pulling the annual rate of food inflation down to 6%, compared with 7% in February and a recent peak of 14.4% in March 2023.


Despite the moderation in food inflation, the overall rate of inflation rose to 5.6% in February, up significantly from 5.3% in January 2024, while core inflation rose from 4.6% to 5%. Although core inflation has been inside the target range of 3% to 6% for the past 34 months, this is the highest level of core inflation since June 2023. It is likely to concern the Reserve Bank, given its efforts to get inflation anchored around the midpoint (4.5%) of the inflation target.


In 2023, SA’s inflation rate averaged 5.9%, down from 6.9% in 2022, but up from 4.5% in 2021, 3.3% in 2020, and 4.1% in 2019. For 2024, inflation is forecast to average 5.2%, although this has been revised up from an expected average of 4.9% as recently as December 2023.


Unfortunately, further upside risks to inflation linger, including second-round effects related to higher electricity and water prices, the recent upward pressure on the oil price, and rand weakness. Fortunately, some of these risks are being mitigated by the already high interest rates as well as the fact that sluggish economic activity makes it harder for companies to pass on some of these price pressures. These mitigating factors could allow the Reserve Bank to start to cut interest rates in the second half of 2024.


At its most recent monetary policy meeting towards the end of March 2024, the Reserve Bank decided to keep the repo rate (repurchase rate) unchanged at 8.25%. It highlighted that although interest rates are restrictive, services inflation has become more entrenched at a higher level and inflation expectations remain relatively elevated. Since November 2021, the repo rate has increased by a total of 475 bps, taking it to its highest level since April 2009 – effectively the highest interest rates in 14 years. The Reserve Bank governor also emphasised that 4.5% is the real inflation target and that the current inflation rate of 5.6% is closer to the top end of the 3% to 6% target range than the midpoint.


The combination of upside risks to inflation, coupled with a desire to see SA’s inflation rate revert to 4.5%, suggests that although interest rates have peaked, the repo rate is likely to stay elevated for at least a few more months than previously expected. At this stage we expect interest will remain unchanged well into the second half of 2024, with a cut in rates possible by the middle of Q3 2024, especially if the US continues to delay its own rate cutting cycle.   

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