Two-speed economies in the US and Europe

Despite one of the most aggressive monetary tightening cycles in history, the US and the euro area are currently two-speed economies, with services doing fine whereas manufacturing is wilting. Divergence between manufacturing and services sector performance is not uncommon, especially in recent decades, occurring more frequently in the later stage of the business cycle. In fact, past US recessions have almost always been led by contraction in the goods sector. 

A resilient labour market is underpinning robust services activity on both sides of the Atlantic. But the labour market has always been a lagging indicator, and we suspect its sensitivity to interest rates and economic growth is lower in this cycle than in previous ones. If this is the case, it would strengthen the argument for policy rates for keeping policy rates high to dampen demand and battle inflation.

Overall, while the US economy has shown extraordinary resilience in the face of successive rate rises, we think some cracks are starting to show. We expect weakness in the goods sector and a slowdown in services to lead to a mild recession in the US, culminating around the turn of the year. We now see a peak-to-trough real GDP decline of -1.0%, revised up from our previous forecast of -1.8% and significantly below a median -2.2% contraction in recessions. 

In the euro area, we expect weakness in manufacturing sector to continue and services activity to gradually slow in the coming quarters. The resilient labour market and real wage gains should support household spending but tighter financial conditions should weigh on investment. In all, after a modest rebound in Q2, we expect growth to stagnate in H2 2023. We expect euro area GDP to expand by 0.5% in 2023 as a whole, with more services-driven economies doing better than economies more manufacturing-oriented such as Germany.