However, a year on, the world’s developed economies all sit in very different positions.
Speaking to Investment Week, Jon Maier, CIO of Global X, said: “In the ever-evolving landscape of global economics, one cannot overlook the divergent paths of inflation in the United States with counterparts across the Atlantic.”
The US seems to have met its fabled ‘soft landing’, with inflation now sitting at a semi-comfortable 3%, while unemployment continues to fall to record lows and growth remains steadily above zero.
In contrast, the UK has fared far worse, as inflation seemed forever stuck in the high single digits, even with the recent drop.
Maier noted that the UK’s inflation trajectory “stands out among its G7 counterparts”, displaying a divergence of approximately 3.5 percentage points above the G7 average.
Other developed nations have all landed somewhere in the middle between the two. While most have finally got a handle on rising prices, Europe’s north has been seemingly hit hardest, with nations such as Germany falling into recession earlier this year.
To understand the reasons for divergence, Isabel Albarran, investment officer at Close Brothers Asset Management argued it was key to remember that the pandemic “ended at different points in different regions”.
“For example, the fact that Japan experienced disruption for far longer than the UK, and that the UK experienced disruption for longer than the US,” she said.
Beyond this, there have been clear structural reasons why some countries have fared better than others in the face of rising prices and potential recessions.
Fahad Kamal, CIO of SG Kleinwort Hambros, explained that the US “escaped the worst of the energy rout” suffered by Europe by tapping into local oil and gas reserves and instead experienced a very tight labour market, he said, while the UK was “hit from both sides”, partially due to labour supply shortages after Brexit.
Meanwhile, Nathan Thooft, CIO for Manulife’s Multi-Asset Solutions team, argued that the fiscal policy pursued by the US has benefitted it in its fight against inflation, whilst also allowing it to avoid a ‘hard landing’.
Gero Jung, chief economist of Mirabaud Asset Management, agreed, stating: “The fiscal stimulus in the US – more than 25% of GDP in aggregate – was much more important than in many European countries.”
“In addition, on the monetary side, QE – and now QT – from the different central banks do have different timings, with varying effects on inflation,” he added.
Looking ahead, Kevin Thozet, member of the Investment Committee at Carmignac, said that the main difference between the central banks “could well be on their approach to their balance sheets”.
“The Fed is trying its best to making its winding down as quiet as possible, while the ECB could accelerate on that front and bring forward its balance sheet drawdown from end of 2024 to mid-2024, a scenario which would be painful for sovereign spreads,” he explained.
Manulife’s Thoost added that in the medium- to long-term, once central banks are able to tame inflation, “the speed of a given central bank’s return to more neutral policy rates across regions will be a function of economic weakness”, as those with weaker growth prospects will be able to pull back from their hiking cycles faster.
As the Fed has almost brought inflation back to target, it is expected that it will be be in a position to “de-emphasise inflation as their singular area of focus”, with their dual mandate on maximising employment, in contrast to the lagging Bank of England and European Central Bank.
“History also tells us the ECB (and Bundesbank prior to ECB) tended to be more measured in their tightening cycle with policy rates peaking lower (compared to the US and UK) but staying there longer,” added Ivanova.
Maier viewed this divergence in inflation as an “opportunity for the ECB to bridge the gap and align its policies more closely with its American counterpart”, though he warned of the “additional hurdle” that Europe faced in a less effective monetary transmission mechanism.
“Banks, reluctant to pass on the official policy rate, are maintaining depressed deposit rates,” he said.
However, Horrocks warned that the Fed leading the charge, creating a disparity in rate cycles, “may make the Euro stronger against the dollar and put the EU and the UK in danger of recession”.
Europe
The divergence between the strength of Southern Europe and the rest of the continent has also been a notable event over the last year, as traditionally richer Northern Europe has struggled to tame inflation and keep GDP growing.
Alexandra Ivanova, fixed income fund manager at Invesco, explained that Southern Europe has a higher unemployment rate, “keeping more of a lid of wage demands”, while a tight labour market has “limited growth in countries such as Germany”.
She also pointed to other important factors, such as the greater dependence on natural gas from Northern Europe, as well as looser fiscal policy boosting growth in Southern Europe.
“In Italy, for example, the super bonus tax credit – aimed at making housing more energy efficient – has led to a notable acceleration in construction,” she said.
“Germany is highly sensitive to natural gas prices,” added Thoost. “Conversely, Spain’s robust renewable energy profile has cushioned the country from the issues experienced in other parts of Europe.”
Robert Horrocks, CIO of Matthews Asia, also cited the previously weaker Euro, which allowed Southern Europe to boost exports, though warned the recent rise in the currency could lead this to become “short lived”.
Tourism has been another large boost for the south of the continent, with Carmignac’s Thozet noting the “significant support from Next Generation EU fund”, which has pushed up the GDP of Southern European countries such as Italy by up to 1%, while Ivanova pointed to the reopening of Chinese travel as a key boost to the sector.
“In Spain and Italy, for instance, tourism represents about one-tenth of aggregate economic activity,” said Jung.
Horrocks also said that “huge rise in Chinese automotive exports which may be pressuring some of Europe’s manufacturing centres” had also disadvantaged nations such as Germany.
However, the somewhat lacklustre reopening of China had also played a part in the divergence, with more a focus on domestic demand, has been a loss for Northern European economies, as they are “more sensitive to the industrial Chinese cycle”, said Ivanova.
Australia and Canada
Meanwhile, Australia and Canada have so far surprised to the upside, but Wei Li, global chief investment strategist for BlackRock, argued that this will be short lived, as “we are starting to see evidence of damage in the credit-sensitive segments of the economy and risks to the consumer”.
She noted that both central banks have resumed hiking rates after initially pausing, citing evidence of persistent inflation.
The two small economies generally overlooked by macroeconomic analysis have provided “important lessons” on inflation, said Thooft.
Australian inflation throughout Q2 2023 sat at 7%, while Canada has surged ahead of even the US in its battle to bring down price increases, registering 2.8% inflation throughout June 2023.
Thooft noted that both economies were open, becoming more disrupted by supply side and global factors, particularly as commodity-sensitive economies. Both central bank “also have less direct control” over inflation as a result, he said.
“Meanwhile, interest rate hikes while arguably being less effective at dampening these outside-driven forces of inflation are also more powerful and damaging to growth and demand given more elevated levels of debt than we see elsewhere,” he added.
Kamal also noted that Australia and Canada were both significant net exporters of energy, so have been “shielded from the worst of the surge in energy prices”.
