Issue link: https://read.uberflip.com/i/1507206
United States In the United States, the recovery from the shortest recession in more than 150 years— a two-month downturn in early 2020—has endured one of the most aggressive interest rate-hiking cycles in Federal Reserve history. Recent growth has been stable at about 2%, annualized. We still assign a high probability to a recession, though the odds have risen that it could be delayed from 2023 to 2024. Shelter inflation should slow in the second half of 2023 and return to its pre-pandemic pace by 2024. Slowing momentum in labor markets should also lower ex-shelter services inflation later this year. In our initial outlook for 2023, we described a weakening of the labor market (along with slowing growth) as a necessary condition for falling rates of inflation. However, the labor market is still resilient even as disinflation has continued. Unemployment remains below 4%, where it stood when the Fed started its current rate-hiking cycle. We continue to expect some softening. Given the long and variable lags between monetary policy shifts and discernible changes in economic activity, Federal Reserve policymakers could decide that the 500 basis points (5 percentage points) of interest rate hikes they've enacted since March 2022 are enough to knock inflation down to their 2% target. But we view at least one more rate increase as probable. Euro area In the euro area, we expect the slight economic contraction in the fourth quarter of 2022 and the first quarter of 2023, likely caused by the energy crisis, to give way to a new but short-lived expansion. Another downturn is likely to arrive this year or next as the lagged effects of monetary policy tightening are realized. By any measure, euro area inflation has declined meaningfully. Falling energy prices should help the headline inflation rate to further ease in coming months. Service-price inflation, linked to wage growth, is stickier and central to our expectation that core inflation will end 2023 at 3.3%, still well above the 2% European Central Bank (ECB) target. The ECB has hiked interest rates by 400 basis points (4 percentage points) in 12 months. We expect one or two additional increases in 2023. Currently 3.5%, a deposit rate of 3.75%–4% would represent a restrictive policy stance. (The deposit rate is the annualized rate of interest paid by the ECB on banks' overnight deposits.) It would exceed our inflation forecast and be more than twice our 1.5%–2% estimate of the region's neutral rate of interest, a theoretical rate that neither stimulates nor inhibits growth. After peaking in 2020 at 8.6% amid the COVID-19 pandemic, the unemployment rate eased to 6.5% in April 2023. We foresee a partial retracement to 7%–7.5% by year-end as the ECB's inflation- fighting campaign passes the one-year mark. 2