War and signs of soft landing

Further uncertainty was added to the global economy with the Hamas attack on Israel and breakout of war. In itself, Israel is only a relatively small producer of natural gas but given the strained gas market in Europe, there was an initial reaction in the form of higher prices. Oil prices were also modestly higher, driven by the risk that the conflict will escalate further and for example lead to tightened sanctions against Iran. Potentially, higher energy prices could give both a positive impulse to inflation and a negative impulse to growth, creating a dilemma for central banks, which would normally not react strongly to such supply chocks but might have to now, given that inflation is already too high. However, energy prices are less likely to rise sharply now than for example last year, were the global economy was growing strongly. The situation clearly adds to the already large geopolitical tensions and creates further uncertainty and risk aversion among investors, although the global economic impact for now is not large.

Economic data has been mixed in the US. Annualised GDP growth was 4.9% in Q3 largely driven by consumer spending, but growth indicators for October pointed somewhat down, and the October job report was weaker than expected. Inflation was higher than expected in September, but despite the high numbers, the Fed kept interest rates unchanged. As previously, the thinking is that just maintaining high interest rates will dampen the economy and inflation going forward, now also with the addition of continuously increasing long-term bond yields, which are reflected in for example 30-year mortgage rates approaching 8%. We also expect tightening financial conditions to dampen the economy markedly going forward, and still see a risk for a hard landing.

In Europe, inflation is clearly declining. According to the ECB’s calculations, core prices (excluding energy and food) have increased less month to month in both September and October than they would if inflation was running steadily at 2% per year. This should be taken with a grain of salt and wage pressures are still likely to lead to more inflation going forward, but the likelihood of more rate hikes from the ECB has become small, in our view, not least since higher bond yields in the US are also affecting Europe. The euro area economy is stagnating with GDP declining 0.1% in Q3 and with more small signs of weakness appearing in the labour market, as unemployment increased to 6.5% in September from the all-time low of 6.4%. These data are consistent with a soft landing for the euro area economy, but it is too soon to conclude that we are in fact seeing that.

The Bank of Japan tweaked its monetary policy by removing its pledge to by an unlimited amount of bonds if necessary to prevent 10-year yields to exceed 1%. The bank has also lifted its inflation forecast for fiscal 2024 to 2.8% from 1.9% in a sign that it is coming around to the view that inflation above 2% is not only a short-run phenomenon. We see this month’s tweak as a further cautious step towards normalisation of monetary policy. Our impression from China is that growth is significantly constrained by weak consumer and business sentiment and that there is definite risk of financial crisis related to the housing sector. On the other hand, the government is showing signs of increasing stimulus and going for rather high growth of 5%, see Postcard from China, 31 October 2023.

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