The year 2024 seen by... Michala Marcussen

Translation of an article published by Wansquare on 29 December 2023
By Michala MARCUSSEN, Group Chief Economist

What is your growth scenario for Europe and France for 2024? How do the three geopolitical risks (war in Ukraine, Israeli-Palestinian conflict, and the U.S. presidential election) affect your forecast?

Economic growth in the euro area slowed in 2023 as the unusual savings buffers built up during the pandemic continued to fade and monetary policy tightening started to bite. Looking ahead to 2024, twin policy tightening looms as fiscal policy joins monetary policy in a more restrictive stance. Easing headline inflation will nonetheless bring some respite for purchasing power and this, combined with Next Generation EU investments should help keep a deep recession at bay. Overall, we expect growth for both the euro area and France to clock in around 0.5% of GDP next year.

The situation on European energy markets heading into this winter stands in sharp contrast to last year, with ongoing efforts to secure energy security paying off. Globally, weaker demand combined with higher non-OPEC production have kept oil prices in check. The risk of the ongoing war in Ukraine and the Israel-Hamas conflict spilling over to both energy markets and broader uncertainty remains high. Such a scenario would add significant global economic costs to already horrific humanitarian costs.

2024 also bring several key elections, not least in Taiwan, Europe (European Parliament) and US. All three could have important geopolitical consequences and also shape the World’s ability to fight climate change and protect nature.

Are you worried about the rise in business insolvencies?

One of the most notable economic features of the pandemic was the exceptionally low level of business insolvencies, as government support measures protected companies from the fallout of health-related lockdowns. As the economy reopened, the subsequent strong rebound provided further support. These exceptionally low business failures also came hand in hand with an exceptionally tight labour market.

With the end of the post-lockdown demand rebound and the removal of government support measures, a normalisation of business failures is now unfolding. Moreover, with demand conditioning weakening and corporate balance sheets under pressure from tighter financing conditions, we expect the see the usual cyclical pattern on business cycle failures looking ahead. With corporate margins coming under increased pressure from weaker demand and lower pricing power, companies are now also beginning to adapt on the labour front and the first signs of a softer labour market are beginning to appear.

It is important now that central banks on both sides of the Atlantic respond to the economic downturn in a timely fashion with rate cuts.

Central banks have sharply increased their interest rates in recent months, do you think this is enough to bring inflation down to 2% at an annual rate? Are you in favour of raising this target?

Both headline and core inflation readings have eased lower in recent months and medium-term inflation expectations remain in check. There is, moreover, very little evidence to suggest the emergence of wage-price spirals. Instead, what we have observed to date suggests that the main force behind the now easing high inflation episode was one of temporary supply shocks generating a lagged response as they worked their way through the various linages in the economy across energy, goods and service prices.

The danger now is that central banks fail to respond with monetary easing in time to this easing inflation picture. The risk is then to see a deeper economic downturn with inflation again falling below target.

Price stability is not helped by moving inflation targets. Quite to the contrary, it sems likely that part of the reason that inflation expectations have remained well anchored is that central banks enjoy a credibility premium. In a World with more frequent relative price shocks, central banks will need to be more agile and governments must follow the advice for any fiscal measures supporting low income households to be temporary, targeted and tailored.

Bond markets have shown strong signs of nervousness lately, do you think that the costs to which governments and companies finance themselves could increase further after the end of the rise in key interest rates?

Financing conditions have tightened substantially as evidenced not least by bank lending surveys on both sides of the Atlantic. The key metric for governments and companies alike is the dynamic between real interest rate costs on the debt stock and real growth dynamics. Looking ahead, much of the debt raised during the exceptionally low interest rate period will come due for refinancing over the coming years. Even if bond yields ease lower from current levels, this will likely still entail higher financing costs on the existing debt stock.

Faced with weaker economic growth, and in the case of European governments the return of full application of the fiscal rules, the pressure to reign back debt will remain significant. A further point to note in the case of governments is that these will no longer benefit from the favourable effect previously generated by central banks quantitative easing (QE) policies.

Earlier this year, US tech banks went bankrupt and UBS was forced to bail out Credit Suisse, what do you think is the biggest risk to financial stability that could emerge in 2024?

Recession and all that this implies for asset valuations, be it financial or real estate, remains the primary risk for both economic and financial stability. The present situation is nonetheless very different from that of the Great Financial Crisis, with banks now well capitalised and enjoying stronger funding structures. The strength of the euro area’s supervisory practices was also evident during the spring turmoil in the US and Switzerland.

Zooming in on the euro area, the greatest risk that I see today is financial fragmentation. Banking Union remains incomplete, and Capital Market Union is still struggling to get away from the starting block. While a replay of the euro area debt crisis is highly unlikely, the slow grind cost hereof remains very high to European households and business alike, in the form of significantly lower trend potential growth and in terms of strategic autonomy. Securing a strong Financial Union for Europe is critical also for the investments need to drive the green and digital transition.

In the case of France, is the housing crisis a ticking time bomb? If so, what measures would you recommend to defuse it?

Tighter financing conditions have brought about an adjustment to house prices in France and several other major economies. It’s worth keeping in mind, that this follows a period of several years of price gains and to date it is premature to talk about a house price crisis. A further point worth note is that in contrast to the time of the Great Financial Crisis, there is little evidence to suggest a major housing stock overhang relative to demand in most major advanced economies.

Looking ahead, some further house price correction seems likely given the lacklustre economic outlook and still tight funding conditions. The main challenge I see today is to facilitate the energy transition of the housing stock in France. Poorly designed and poorly phased policies risk costly housing market frictions and, as already seen across the Rhine, can also result in a backlash of public opinion against green policies. Conversely, well designed policies have opportunity not only to accelerate the move to less carbon intensive homes, but also to secure a source of economic growth from investments. Here again a strong European financial system is key.