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Key Points

• Cracks appearing in the resilience of the economy – precisely when central banks were getting impatient
• We revisit our macro scenarios at mid-year.

The economy’s impressive resilience so far across the Atlantic has been a key ingredient in the central banks’ willingness to toughen up their stance to fight the inflation spike. If the usual “self-stabilizing forces” – e.g., a deceleration in consumption brought about by rising prices – do not show up, then the Fed and the ECB feel even more the need to bring forward their rate hikes. However, it is precisely at the moment this new resolve is communicated that signs of deceleration are appearing. The lower-than-expected PMI readings for June in both the US and the Euro area, together with a less concerning second estimate of US consumers’ inflation forecasts in the Michigan survey for June have triggered a – rare – downward revision in the market’s expectations for the Fed Funds trajectory. Besides, with no further Covid flare-up in China for now, the global economy may avoid another source of supply-side inflationary pressure through the price of manufactured goods. Finally, oil prices have moderated.

Key releases are coming out this week to gauge the speed of the correction in growth, but as we revisit at mid-year our forecasts, a painful but manageable landing is our baseline. We expect lower GDP growth in the US and the Euro area than the two central banks, but it’s precisely the reason why we think they won’t tighten as much as what they are communicating, which may offer some relief to the markets by the turn of the year. Still, we need to keep an eye on an alternative “persistent inflation” scenario which would force more monetary policy action. We don’t think it could take the same form across the Atlantic. In the US, inflation may be difficult to tame because wage growth remains too strong. The inflation drift would then come mainly from “core”, which would make the Fed’s job simple, albeit painful. In Europe, another exogenous shock such as a further sharp rise in gas prices – which have already moved up last week in reaction to Russia’s move on supply – is a more natural candidate. The ECB would probably continue hiking moderately to anchor inflation expectations, but we would expect some tension between governments and the central bank, while the probability to be forced to deploy an “anti-fragmentation” tool would be high – although the governments’ capacity to deliver on even light conditionality would be lower.