Economic Outlook – 18 December 2022


The Consumer Price Index and Federal Open Market Committee meeting took center stage. Headline CPI surprised to the downside, rising just 0.1% in November. On a YoY basis, consumer price growth softened to 7.1%, down from 7.7% in October. Energy weighed on the overall index as gasoline prices slid 2.0% and energy services dipped 1.1%. Food, another major strain on households this year, is showing signs of easing—November’s 0.5% gain was the slowest in 12 months. The decline in gasoline prices is expected to pressure transportation costs lower, providing scope for food prices to roll over in the coming months.   The core CPI, which excludes energy and food, also came in lower than expected and increased 0.2% in November. Core goods prices fell 0.5%, its second straight monthly decline, with notable decreases in used vehicles (-2.9%), education & communication products (-1.6%) and recreation goods (-0.4%). Meanwhile, core services advanced 0.4%. Owners equivalent rent picked up over the month, as did recreation and personal care services. Strong wage growth, often the largest input cost for service providers, is likely to keep the heat turned up on services inflation for some time   Retail sales slipped 0.6% in November, which is the largest drop of the year. Eight of the 12 major industry components fell, with building material stores (-2.5%), motor vehicle & parts dealers (-2.3%) and furniture stores (-2.2%) seeing notable declines. Most of these categories offer products that are purchased with financing. Still-elevated goods prices combined with climbing interest rates make financing an unattractive option for many, which is likely driving the softening in demand for big-ticket items. While the overall sales report was a flop, it may be a reflection of consumer spending shifting toward services categories that are not captured in the retail sales survey   Production has struggled to gain footing this year amid still gummed-up supply chains and tight labor supply. November’s reading was the largest decline of the year and marked the fifth negative print out of the past seven months. Manufacturing output (-0.6%) was the real source of weakness last month and suggests that firms are starting to pull back on production. Purchasing manager surveys support the notion, with the New York Fed’s and Philadelphia Fed’s indices falling further into negative territory in December   The Fed met market expectations, increasing the policy rate by “only” 50 basis-points (bps), bringing the upper-bound to 4.5%. That marked a slowdown from the 75-bps pace undertaken at the four prior meetings, but still stands as a historically fast pace of policy adjustment. Beyond the interest rate announcement, the FOMC also released updated economic projections. Relative to the September assessment, Committee participants now expect growth to be considerably weaker in 2023 (0.5% vs 1.2%) and the unemployment rate slightly higher (4.6% vs. 4.4%). Despite the more downbeat outlook, policymakers view price pressures as having become more entrenched, and upgraded the inflation outlook through 2024. As a result, the FOMC signaled rates are likely to move at least 50-bps higher than previously expected next year – implying a terminal rate of 5.25% – with cuts not beginning until 2024.   In the press conference, Chair Powell struck a somewhat hawkish tone. When asked about the recent easing in financial market conditions, Powell stated that the Committee looks through near-term swings, but emphasized the importance of market conditions aligning to the Fed’s intentions. Moreover, Powell was quick to direct focus to the upward revision to the “dots”, reiterating that the Committee’s view on inflation remains skewed to the upside and thus future projections could still show an even higher terminal rate. Despite this deliberate signaling, market participants still believe that the Fed will begin cutting rates late next year   Intensified fears over rising interest rates pushed the S&P 500 Index lower for a second consecutive week and to levels last seen in early November. Nearly every sector within the index recorded sharp losses with the exception of energy shares, which were supported by a partial rebound in oil prices. A roughly USD 4 trillion expiration in options contracts on Friday sparked additional volatility. They also observed that trading in exchange-traded funds (ETFs) reached near record levels at midweek, indicative of investors moving in and out of stocks as a whole in response to broader economic signals   In terms of data release, Leading Economic Index is out on Wednesday. The recent downtrend in building permits is one reason why most likely the Leading Economic Index (LEI) might have declined again in November. The LEI has declined in eight of the past 10 months and fell 0.8% in October. The monthly drop was led by lower consumer expectations and unemployment insurance claims. The data that are used as an input to the LEI suggest that the index likely slipped again in November. Stock prices generally improved on balance during the month, and consumer sentiment improved slightly in November. That said, jobless claims trended slightly higher in November and ISM services new orders fell back slightly during the month. As mentioned previously, building permits will likely continue to be a drag on the headline index moving forward   Personal Income & spending is out on Friday. The consumer has brushed off rising inflation and maintained a solid pace of spending for much of the past year. Personal spending easily beat expectations and rose 0.8% in October. Even after accounting for inflation, real personal spending increased at a robust 0.5% rate. That said, there are signs the reduced purchasing power is starting to catch up. Retail sales dropped more than expected in November, a decline that reflects consumers shifting to services. But, the retreat is also a reminder that overall spending is likely to slow as inflation eats away at the savings consumers have been using to fuel spending.    


UK CPI inflation appears to be past its peak. UK CPI YoY fell from its October level of 11.1% to 10.7% in November, which was 0.2pp lower than market expectations. The drop in the annual rate of CPI inflation reflected price changes across a wide range of items including motor fuels, second-hand cars, tobacco, accommodation services, clothing and footwear, and games, toys and hobbies. The largest upward effect, which partially offset this, came from increases in prices for alcohol in restaurants and pubs. Along with the headline rate of inflation, core CPI (excludes energy and food) also saw its rate ease: YoY core CPI dropped from 6.5% to 6.3% in November. This was driven by a drop of 0.7pp in goods inflation while services inflation edged up 0.1pp (comparing October and November’s YoY figures). YoY, goods CPIH inflation stands at 14.1% and services CPIH registers at 5.4% for November   The Bank of England’s (BoE’s) Monetary Policy Committee (MPC) has voted by 6-3 to raise interest rates by 50bp, meaning UK interest rates now sit at 3.5%. This was expected and had been priced as the most likely outcome by markets. There was a small probability of the BoE going further with a 75bp hike, but data released this week showing a marginal easing in the labour market and inflation coming in lower than expected, will no doubt have tilted the balance of opinion on the MPC towards a 50bp hike. However, there were, of course, significant differences of view among MPC members. One member of the committee voted for a larger 75bp increase on the basis that price and wage pressures could stay stronger for longer than projected in the BoE’s November report; on the flip side, two members voted for no change to interest rates, arguing that the current bank rate was more than sufficient to bring inflation back to target in the medium term   The MPC will need to weigh up various competing priorities. The BoE confirms that the UK is probably in recession – which will act as a natural brake on inflation – and the MPC will also be conscious of financial stability risks arising from the already started correction in the property market. All things considered, the BoE will increase rates further to a peak of 4%, which is below current market expectations   Consumer confidence, as measured by the GfK metric, rose by two points in December but remains at a highly depressed level (-42). The barometer has now registered lower than -40 for eight months in a row, the first time since records began nearly 50 years ago. It is also notable that there was no improvement in consumers’ perception of their personal financial situation over the next 12 months. Retail sales numbers out for the month of November reinforce how cautious consumers are at the moment. Sales by volume fell by 0.6% MoM, worse than market expectations of 0.3% growth. Retail sales by volume have been on a downward trend since June 2021    The composite PMI came in at 49 in December which, while indicating contraction, was better than expectations (consensus: 48) and up from the previous month’s figure of 48.2. This was driven by an improvement in the services PMI, now up to 50. On the flip side, the manufacturing sector appears to be entering into a deeper contractionary phase: UK manufacturing PMI registered at 46.5 in December, well below the level of 50 that would indicate expansion.


The Governing Council (GC) decided to raise its policy rates by 50bp and, “based on the substantial upward revision to the inflation outlook, expects to raise them further.”  Moreover, the statement indicated: “interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term target.”  One direct interpretation of this statement is that the February meeting will likely see another 50bp hike.
The GC also stated: “from the beginning of March 2023 and onwards, the asset purchase programme (APP) portfolio will decline at a measured and predictable pace, as the Eurosystem will not reinvest all of the principal payments from maturing securities… This decline will amount to EUR 15 billion per month on average until the end of the second quarter of 2023 and its subsequent pace will be determined over time.” Detailed parameters for reducing the APP holdings will be announced after the February 2023 meeting. The GC will continue to reassess the principles of its bond holdings programmes. In addition, by the end of 2023, the GC will also review its operational framework for steering short-term interest rates, which will provide information regarding the endpoint of the balance sheet normalisation process   The December update to the ECB Macroeconomic Projections significantly lifted the inflation projections. The press statement made clear that inflation would remain far too high and was projected to stay above the target for too long. Average inflation is now expected to reach 8.4 percent in 2022 before decreasing to 6.3 percent in 2023, with inflation expected to decline markedly over the course of the year. Inflation is then projected to average 3.4 percent in 2024 and 2.3 percent in 2025. Inflation excluding energy and food is projected to be 3.9 percent on average in 2022 and to rise to 4.2 percent in 2023, before falling to 2.8 percent in 2024 and 2.4 percent in 2025. The projections also see the Eurozone economy contracting in the current quarter and the next quarter, owing to the energy crisis, high uncertainty, weakening global economic activity and tighter financing conditions. Any recession would be relatively short-lived and shallow, according to the projections, but growth is nonetheless expected to be subdued next year and has been revised down significantly compared with the previous projections. Overall, the Eurosystem staff projections now see the economy growing by 3.4 percent in 2022, 0.5 percent in 2023, 1.9 percent in 2024 and 1.8 percent in 2025   The Eurozone flash Composite PMI increased to 48.8 in December, compared with 47.8 the previous month. The Manufacturing PMI also increased, rising to 47.8, compared with 47.1 earlier, and the Services PMI was 49.1 compared to 48.5 the previous month. All three series were above expectations. The eurozone downturn extended into its sixth successive month in December, according to flash PMI data, although the rate of the decline in business activity moderated for a second month in a row amid some easing in new orders, improving supply conditions, lower price pressures and an uplift in business confidence. Business costs also rose at the slowest rate for over one and-a-half years, reflecting the combination of lower demand and improved supply, the latter signalled by the first quickening of supplier delivery times since the pandemic began. That said, the overall business sentiment remains subdued   Shares in Europe fell sharply after central banks indicated that interest rates would likely need to rise further and for longer than markets previously hoped. In local currency terms, the pan-European STOXX Europe 600 Index ended the week 3.28% lower. Major stock indexes also weakened. Germany’s DAX Index dropped 3.32%, France’s CAC 40 Index lost 3.37%, and Italy’s FTSE MIB Index slid 2.43%.


The People’s Bank of China (PBOC) injected a higher-than-expected CNY 650 billion into the banking system through its one-year medium-term lending facility (MLF) in its first cash injection since March. Analysts said the move was aimed at maintaining sufficient liquidity in China’s financial system as it prepares for a full reopening in January 2023. However, the central bank left the one-year MLF rate, a key benchmark lending rate, unchanged at 2.75%   Senior officials drafted the policy agenda for China’s economy in 2023 during the Central Economic Work Conference, an annual meeting that sets economic policy for the coming year. Officials reportedly set out guidelines aimed at boosting domestic consumption and investment to drive growth through 2035 as China continues to struggle with virus-related headwinds and weakening external demand. Sectors targeted for supportive measures include housing, tourism, electric vehicle manufacturing, health care, and education   Chinese stocks fell as weaker-than-expected economic data dampened investor sentiment. The Shanghai Composite Index was down 1.22% and the blue-chip CSI 300 Index declined 1.1%, reversing several weeks of gains. Remarks from Vice Premier Liu He indicating that Beijing is considering new measures to support the real estate industry lifted property sector stocks.

Sources: T. Rowe Price, MFS Investments, Wells Fargo, TD Economics, Handelsbanken Capital Markets, M. Cassar Derjavets