Economists' Outlook Brightens as China Reopens and Data Surprises

After China's reopening and a series of positive data surprises in recent weeks, economists are revising their previously pessimistic outlooks for the global economy.

Data releases last week showed signs of inflation slowing and less severe downturns in activity, prompting Barclays to raise its global growth forecast to 2.2% in 2023. This is up 0.5 percentage points from its last estimate in mid-November.

According to Barclays Head of Economic Research Christian Keller, the company has revised its growth predictions for several major economies. China is now expected to grow by 4.8%, up from last week's prediction of 4.0%. The euro area is also forecast to see positive growth of 0.1%, thanks largely to an improved outlook for Germany. Other economies that have been upgraded include the United States (0.6%), Japan (1.0%) and the United Kingdom (-0.7%).

The United States would still experience a recession, as we predict slightly negative growth in three quarters (Q2 -Q4 2023), but it would be quite shallow. Annual 2023 GDP growth would now remain positive.

The U.S. Consumer Price Index for December edged down 0.1% from the previous month, coming in at 6.5% on an annual basis. This was in line with expectations and was mostly driven by falling energy prices and slowing food price increases.

Keller suggested that a more important gauge of how the U.S. economy is faring, and how the Federal Reserve’s monetary policy tightening might unfold, is the December Atlanta Fed Wage tracker.

The estimate last week supported the previous week’s average hourly earnings (AHE) data, indicating a sharp deceleration of wage pressures. The AHE declined by a full percentage point to 5.5% year-on-year.

Philadelphia Fed President Patrick Harker, a new voting member of the Federal Open Market Committee, said last week that 25 basis point interest rate hikes would be appropriate moving forward. A similar tone was struck by Boston Fed President Susan Collins and San Francisco Fed President Mary Daly. All three presidents noted that the economy is strong and that inflation is near the Fed's target level of 2 percent.

The central bank has been raising rates aggressively to rein in inflation while hoping to engineer a soft landing for the U.S. economy. In line with market pricing, Barclays believes the balance on the FOMC has now shifted toward 25 basis point increments from February’s meeting onward. This shift suggests that the central bank is confident that inflation is under control and that the economy is on track for a soft landing.

Barclays projects that the Federal Reserve will raise the Fed funds rate to 5.25% at its May meeting, exceeding current market pricing for a peak of just below 5%. This is based on the bank's expectations for the terminal rate, or the rate at which the Fed will end its hiking cycle. Policymakers are waiting to see more evidence of slowing labor demand and wage pressures before making a decision.

Barclays suggested that the euro area's sticky core inflation will keep the European Central Bank on track to deliver its two telegraphed 50 basis point hikes in February and March, before ending its tightening cycle at a deposit rate of 3%. The bank also said that the ECB will continue to tighten its balance sheet after the rate hikes.

Inflation has been more persistent in the U.K. The labor market is tight, energy bills are increasing in April, and there is widespread industrial action which is causing wage growth to increase. This is prompting economists to warn of potential second round inflationary effects.

Barclays has updated its outlook to reflect a further 25 basis point interest rate hike from the Bank of England in May. This would take the terminal rate to 4.5%. Barclays had previously penciled in a 50 basis point hike in February and a 25 basis point hike in March.

Activity data in the euro zone and the U.K. was surprisingly strong last week, which may give central banks more room to raise rates and bring inflation back to target levels.

Keller said that the better-than-expected GDP data for Germany and the U.K. this week adds further evidence that the economic fallout has been less severe than the much more uncertain energy situation suggested a few months ago.

The large fiscal support packages in Europe and the UK to deal with elevated energy prices, healthy labor market conditions, and robust household savings have all contributed to the current economic situation.

Berenberg has upgraded its forecast for the euro zone in light of recent positive developments, including falling gas prices, a recovery in consumer confidence, and a modest improvement in business expectations.

On Friday, the German federal statistics office released data showing that the country's economy stagnated in the fourth quarter of 2022. This was a better outcome than expected, and Berenberg Chief Economist Holger Schmieding said it has two major implications for the outlook across the eurozone.

First, it suggests that the German economy is more resilient than previously thought.

Second, it raises the possibility that other eurozone economies may also see better-than-expected results in the coming quarters.

According to Schmieding, Germany is more exposed to gas risks than the euro zone as a whole. This suggests that the euro zone likely did not fare much worse than Germany late last year and may have avoided a significant contraction in GDP.

It seems unlikely that Q1 2023 will be much worse than Q4 2022, judging by the ongoing recovery in business and consumer confidence.

Berenberg has revised its forecast for the fourth quarter of 2022 and first quarter of 2023, and now expects a 0.3% decline in cumulative real GDP instead of the 0.9% decline previously forecast.

"The rebound in the second half of 2023 and early 2024 is likely to be less steep than previously thought, with less ground to make up," Schmieding said.

Berenberg has therefore revised its forecast for the annual average change in real GDP in 2023 from a 0.2% shrinkage to 0.3% growth.

The German investment bank has revised its 2023 forecast for the UK, from a 1% contraction to a 0.8% contraction. This is due to Brexit, the legacy of former prime minister Liz Truss’ disastrous economic policy, and a tighter fiscal policy. As a result, the UK is expected to continue to underperform compared to the euro zone.

TS Lombard raised its euro area growth forecast from -0.6% to -0.1% for 2023 on Friday, citing positive economic surprises, unseasonably mild temperatures, and a fast reopening in China.

As more and more forecasts move toward positive growth for the euro zone, TS Lombard Senior Economist Davide Oneglia said that an "L-shaped recovery" is still the most likely scenario for 2023, rather than a full rebound. This means that the economy will slowly improve, rather than bouncing back quickly.

Oneglia said that three major factors will lead to a slowdown in the European economy in the coming quarters: 1) the full effect of ECB tightening will be felt in the real economy; 2) the US economy is weakening; and 3) China is reopening into a weak economy, which will mostly benefit domestic consumer services, with limited benefits for EA capital goods exports.