The Global Economy Remains Resilient

A new Global Economic Outlook & Strategy report from a team led by Citi Chief Economist Nathan Sheets notes that our overarching narrative for the global economy remains broadly intact: Global growth continues to proceed at a solid but slightly below-trend pace. That’s true despite a past month that’s seen a number of important global developments, including China’s stimulus announcement, a surprisingly strong performance for the U.S. economy, broad-based central-bank rate cuts and geopolitical pressures. We see ongoing disinflation as providing central banks with scope to gradually unwind tight monetary policies.

The global economy’s performance during the third quarter was stronger than expected, leading us to raise our forecast for global growth this year to 2.6%. The largest upward revision to our forecast was in the U.S., where consumer spending keeps powering ahead, and the UK, Canada and Mexico also outperformed our expectations. Global growth for 2023 was marked up as well, reflecting large revisions to U.S. Gross Domestic Product (GDP) data.

Global Purchasing Managers’ Indexes (PMIs) point to a two-track global economy: The services sector continues to show strength, with a PMI reading comfortably in expansionary territory, while the manufacturing PMI has moved more deeply into contractionary territory. This contrast is highlighted by the differing performances of the German and Spanish economies: Germany, a trading goods producer, has been slammed by weakness in global manufacturing, while Spain’s more services-oriented economy has kept exceeding expectations.

In considering risks to the outlook, we note geopolitical stresses, election risks and our ongoing worries about the U.S. labor market, though recent data have generally been reassuring. Looking at longer-term risks, we note global debt levels and fiscal performances. We identify a group of major economies that currently have debt levels in excess of 75% of GDP and are projected by the International Monetary Fund to run fiscal deficits at or above 3% of GDP. This group includes the U.S., Japan, France, Italy, the UK, China, India and Brazil. All look to have embraced historically loose fiscal policies as at least an unavoidable fact of life.

Global inflation prospects

Aggregate measures of global inflation have largely returned to pre-pandemic readings, with headline inflation now close to 2% after peaking near 7% in mid-2022. But the more interesting story continues to be the disjuncture between core goods and services inflation. Goods inflation has fallen sharply and recently shown negative readings; going forward, we expect the same pressures that kept it in check before the pandemic to remain in play, such as international competition and ongoing technological advances.

In contrast, services inflation continues to be much stickier. It’s now roughly retreated roughly half the way from its 2023 peak of 5% to its pre-pandemic 2% pace. But we expect it will continue to descend, and an eventual rebalancing of global demand away from services and back toward goods should help loosen labor markets, since services production tends to be labor-intensive.

Implications for central banks

With inflation on a downward trajectory, central banks are now moving to less restrictive policies: Fourteen of 33 major central banks cut rates in September. The Fed’s recent rate reductions led the way, with Fed policymakers judging that the risks around its dual mandate of price stability and full employment had moved back into better balance. We see the Fed as in the midst of a strategic recalibration, as rates don’t need to be so high with inflation coming down, and we expect rate cuts at each of the Fed’s next two meetings.

The European Central Bank (ECB) has now trimmed rates by 75 basis points, and we expect another cut in December. We think further reductions in inflation should give the ECB significant scope for further easing, which we expect will total 150 basis points in 2025.

We see the Bank of Japan (BoJ) gradually lifting rates in 2025, as inflation stabilizes around 2% and economic growth runs at (or above) trend. But with the yen again weaker than 150 against the dollar, pressures may recur for the BoJ to act more aggressively to support Japan’s currency.

Developments in the U.S., euro area and China

The U.S. economy has continued to show strength, with the indomitable U.S. consumer remaining the key engine of growth. By our calculations, the top 40% of U.S. households in terms of income are spending without hesitation, a reflection of strong balance sheets and wage and employment prospects that remain favorable. Meanwhile, the bottom 40% of households are feeling the pinch of higher prices and increased financing costs. The difference is that the top 40% of U.S. households account for 62% of spending, while the bottom 40% account for 22%.

Despite this strength, the labor market remains a source of concern. But while data points suggest a softer labor market, the prints themselves haven’t shown outright weakness. This leads to an alternative interpretation: that the labor market is normalizing from exceptional tightness following the pandemic.

The economy’s recent strength has triggered worries about a re-acceleration of inflation, but we are relatively sanguine on this point. The post-pandemic surge represented a “perfect storm” of supply-chain disruptions, labor-supply shortages, a massive fiscal stimulus and pandemic-induced displacements in demand, and we don’t see such a thing being repeated.

Our forecast for the euro area envisions lackluster growth of roughly 1% through this year and next, a pace just slightly below trend. The ECB’s move to less restrictive policy should help unlock credit growth, which was throttled as the ECB hiked rates and has contracted sharply in real terms. We also note a striking divergence of recent activity within the euro area. The euro area’s aggregate real GDP is close to flat over the past two years, and up just 4% since 2019’s fourth quarter. By comparison, U.S. output has risen 11% during this period. A recent report from Mario Draghi sought to diagnose the euro area’s underlying problems, though we think it’s unlikely that a critical mass of the report’s proposals will be implemented any time soon.

We see growth in China coming in at 4.7% this year, a bit below the government’s 5% target, and growth is likely to slow next year to 4.2%. China’s economy looks like it’s softened in recent months, with consumer confidence mired at low levels. Given these challenges, we welcome the stimulus efforts China has announced, but like other observers we’re waiting more specificity on fiscal measures. The broad categories of fiscal support are clear: financing for local governments, support for households, resources for bank recapitalization and funds to help stabilize the property market. But the composition and size of these measures remains to be seen. The deeper challenges for China, meanwhile, are of a structural nature: The economy faces headwinds from high levels of debt and leverage, aging demographics, high youth unemployment and geopolitical tensions.