Observers note that growth this year in the euro area will rebound from very low levels, as past shocks, and tight monetary policy weigh on activity. Continued high wage growth and persistent services inflation could delay the return of inflation to target (2%). However, unlike in the United States, there is little evidence of overheating, and the European Central Bank will need to carefully calibrate the pivot toward monetary easing to avoid an inflation undershoot.  While labour markets appear strong, that strength could prove illusory if European firms have been hoarding labour in anticipation of a pickup in activity that does not materialize.

Yet, the doves are feeling that once the Middle East hostilities reach a peaceful settlement another renaissance will emerge.

Recently, the ECB forecast projected that inflation will average 2% next year. As can be expected, the ECB is now awaiting its fresh economic forecasts before enacting a first rate cut. A lower inflation projection for 2025 would strengthen the case for a faster pace of cuts.

Hopefully, the initial reduction is widely expected to take place in June 2024. The good news is that most economists now expect a decline in interest rates by the ECB of 25 basis points to 3.75%. Yet, there are different views on the number of additional cuts that could take place by the end of the year, totalling either 75 basis points or 100 basis points to 3%. The kicking of the can down the road has started.

In fact, Europe's major competitors, the US and China, have the advantage of having continental-size economies to generate scale, increase investment and capture market share for the industries that matter.  Europe is fragmented into many different states with minute interest in uniting economically. One hopes that shortly the MEP elections will draw the interest of councillors to rekindle the drive for a common market where members can trade internally without too many restrictions.

The rate of inflation for the euro area declined to 2.4% year-on-year in March and came in lower than expectations and the prior month's data of 2.6%. More exuberant news is that core inflation declined for the eighth straight month in March to 2.9%, the lowest since February 2022, and came in lower than both expectations and the prior month's figure of 3.0% and 3.1% respectively.

It is heartwarming to read that the European Central Bank's Governing Council delivered a dovish message at its April meeting and noted that it would consider cutting interest rates in June, with the market now pricing in three possible rate cuts of 25bp each by year-end.  Incidentally, UK inflation also eased albeit less than expected, sparking concerns of US-style stickiness.

According to official numbers released recently, the UK inflation rate slowed by less than anticipated in March, which adds to cautious indications that a first interest rate cut by the Bank of England may be farther off than previously expected.  Meanwhile, UK retail sales growth picks up as price pressures ease.

Industry data indicates that growth in UK retail sales rose in March after falling to a two-year low in February, suggesting a recovery for the sector as a result of easing price pressures. According to the Office for National Statistics, the annual growth in British consumer prices was 3.2%, down from the 3.4% increase in February and its lowest in two and a half years.

Concurrently, core inflation declined to 4.2% from 4.5% in February. The rate was expected at 4.1%.  As can be expected, food costs contributed to the largest downward contribution to overall inflation, whereas motor fuel prices exerted the largest upward contribution.

Let us discuss Asia.  China's economy remains affected by the downturn in its property sector.  Credit booms and busts never resolve themselves quickly, and this one is no exception.  Domestic demand will remain lacklustre unless strong measures address the root cause.  With depressed domestic demand, external surpluses could well rise. The risk is that this will further exacerbate trade tensions in an already fraught geopolitical environment.

The journey in China has been eventful, starting with supply-chain disruptions in the aftermath of the pandemic, an energy and food crisis triggered by Russia's war on Ukraine, a considerable surge in inflation, followed by a globally synchronized monetary policy tightening. The forecast for global growth five years from now, at 3.1 percent, is at its exemplary albeit not sky high.  Global inflation is forecast to decline steadily, from 6.8 percent in 2023 to 5.9 percent in 2024 and 4.5 percent in 2025, with the most advanced economies returning to their inflation targets sooner than emerging market and developing economies.  In Malta, the Central Bank's latest reports tell us candidly that trends are encouraging, yet we are not there yet.  

Somewhat worryingly, progress toward inflation targets has stalled since the beginning of the year.  This could be a temporary setback, but there are reasons to remain vigilant.  In Europe, most of the good news on inflation came from the decline in energy prices and in goods inflation.  The latter has been helped by easing supply-chain frictions, and helped by the decline in Chinese export prices.  But oil prices have been rising recently in part due to geopolitical tensions and services inflation remains stubbornly high. Should the tensions in the Ukraine war and the Middle East hostilities calm down both events augurs well for a resilient recovery.  Further trade restrictions by US on Chinese exports could also push up goods inflation.  Rejoice, how last year Cyprus ran a surplus.  Greece and Portugal, are close to balancing their budgets.  

On a local scene, we proudly announce that Credit rating agency Morningstar DBRS has confirmed an A rating for Malta's long-term foreign and local currency.  The agency said it believed risks to Malta's credit ratings remain balanced with the economy having strongly recovered from the pandemic.  

Perhaps this is a harbinger to a steady expansion in goods exports together with an improvement in quality of tourist arrivals.  We all concur that extra GDP growth will go some way to quench our 10-billion-euro national debt. 

 

gmm@pkfmalta.com

 

George M Mangion is  Senior Partner at PKF Malta