Inflation is on a fast downward path towards more sustainable levels and is in line with monetary policy targets. Consequently, as inflation was coming down during the winter, financial markets made a quick turnaround, pricing in aggressive cuts in central banks’ policy rates starting in the spring and onwards. Risky assets benefited, equity markets gained in value, credit spreads compressed and yields on long-term government bonds fell. Lately, however, central banks have been trying to push back market pricing with hawkish rhetoric, and markets have adjusted somewhat. At the same time, the economic slowdown is expected to be a soft landing.
Economic activity will come down in the near term; growth will be low, and, in some countries, it will stagnate. However, the economic outlook looks a bit brighter even though the inflation beast has not yet been tamed. Developments during 2024 will depend on whether the disinflation process that started last year can continue at full tilt, allowing central banks to be less restrictive. Currently, the inflation momentum remains stronger in the US than in the eurozone, and likewise the US economy is holding up rather well compared to the low growth in the eurozone. The final sprint of disinflation in the US could be bumpy, whereas inflation in other countries and regions appears to be more steadily on a downhill slope towards inflation targets.
A risk in the current conjuncture is that central banks start cutting policy rates too late, and that monetary policy is not forward-looking enough. If this risk materialises, it could deepen and lengthen the economic slowdown as well as induce volatility in financial markets, resulting in a repricing of risk.
Risks to the outlook are more balanced – the probability of a hard landing seems to be declining – but at the same time, there are risks to the disinflationary process. The current conflict in the Red Sea cannot be compared to the opening effects after the Covid pandemic and the global disruptions it had on supply channels. However, an escalation in the conflict in the Red Sea or, more broadly, in the Middle East could potentially derail the downhill path of inflation. Geopolitical risks remain high and are a risk for the economic outlook, and we still have a war on European soil.
