Economic and financial risk insights: Central banks' inflation and labour markets dual mandate coming more into focus

• Growth: further evidence of cooling in the US. Cautious recovery in Europe continues. Mid-term political uncertainty in both remains high.
• Inflation: back on the disinflation path. While core services inflation remains elevated, we expect a gradual return to 2% over the next 12 months in the US and Europe.  
• Interest rates: inflation and labour markets in focus. More central banks likely to start cutting rates by the year-end. Fiscal uncertainty could raise the term premium of longer-dated bonds in the medium term.

Further moderation in the US economy. So far, 2024 has been a strong period for the global economy but in recent weeks data prints have delivered increasing downside surprises (see Figure 1). In the US, the June employment report saw sturdy headline job gains, though this was offset by sizable negative backward revisions of the prior month (see Figure 2) and a third consecutive increase in the unemployment rate to 4.1% (from 4.0% in May). We see this cooling as part of economic normalisation amid also still-healthy consumer fundamentals. Meanwhile, cautious recovery in Europe continues. Peak election risks in the region have passed but medium-term uncertainty remains high. The French election outcomes suggest a hung parliament with a temporarily policy standstill and, in our view, less fiscal deficit reduction from the incoming government compared with the old.

Figure 1: Economic surprise indices

Figure 2: US nonfarm payrolls and data revisions (3-month moving average)

Inflation: back on the disinflation path. Softer PCE inflation readings in June and CPI in July have instilled more confidence that the US is back on route to 2% target. In Europe, inflation has eased in line with expectations. In both regions, core services inflation remains elevated (see Figure 3), but we continue to expect gradual return towards 2% in the second half of this year in Europe and in early 2025 in the US (Figure 4).In Japan, inflation has eased while corporate inflation expectations remain anchored at around 2%. This should allow the Bank of Japan to gradually normalise policy further this year.

Figure 3: US and euro area inflation developments

Figure 4: US and euro area inflation forecasts

Dual mandate of inflation and labour markets in focus. In the US, a gradually rebalancing labour market and subsiding inflation draw the Federal Reserve (Fed) closer to beginning its slow easing cycle, which we see starting in September (see Figure 5). In the euro area and the UK, we expect cautious rate cuts though labour market developments will be key to watch. Meanwhile, political uncertainty and the associated cloudiness of the fiscal outlook will likely become larger topics in many economies over the medium term. With France's deficit risks extending out to the medium term, we do not expect the current uncertainty risk premium on French bonds to fully unwind. We also expect US Treasury yields to reflect more fiscal concerns in the medium to longer-term.

Figure 5: Implied number of cuts from the US Fed

Figure 6: 10-year France/Germany yield spread

We expect some further global growth moderation in 2H24. Inflation is slowing and labour markets are rebalancing, opening the door for more central banks to join the rate cutting cycle by end this year.