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The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
This is an excerpt from our 2023 Mid-year Investment Outlook, in which specialists from across our investment platform share insights on the economic and market forces that we expect to influence portfolios in the second half of the year. This is a chapter in the Mid-year Global Economic Outlook section.
The recent spike in US financial stress and signs that the US Federal Reserve’s (Fed’s) tightening cycle is nearing an end raise the potential for increased economic divergence between the US and the rest of the world, as discussed in our global macro mid-year outlook. For Europe, the key questions are whether and for how long the euro-area cycle and monetary policy will diverge from the US.
While recent financial stress could represent a downside risk to European growth, we continue to expect supportive policy throughout this year, as well as solid consumer and corporate fundamentals. Combined with growing signs of strong and increasingly embedded inflation, we think this backdrop continues to imply that the European Central Bank (ECB) may need to hike for longer than is being priced by the market. Below are the key considerations that inform this view.
If financial stress were to intensify, that would create some non-policy-induced tightening. However, in the absence of such an adverse scenario, the ECB is likely to keep normalising rates into the autumn. Real rates also suggest upside risk to the amount of tightening the ECB needs to undertake. As illustrated in Figure 1, deflated by consumer medium-term inflation expectations, real rates are only 0.35%, well below the 2% equivalent level in the US.
On balance, investors should therefore prepare for divergence to continue, with varying implications for asset prices in the euro area and beyond.
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