Navigating global economic challenges: Inflation and trade tensions

Mabrouk Chetouane, Head of Global Market Strategy at Natixis Investment Managers is joined by Mirova’s David Belloc, Portfolio Manager and Strategist, and Bertrand Rocher, Co-head of Fixed Income, to discuss the current economic landscape, focusing on inflation, trade tensions, and the implications for European markets.

Mabrouk Chetouane: Europe gives the impression that it is cumulating all the issues. David, could you start by giving us a macroeconomic overview of Europe? What are your expectations regarding growth, inflation, and monetary policy?

David Belloc: We have several ideas about the Eurozone. There is a clear decoupling between Northern and Southern Europe, or let’s say core Europe—France, Germany—and Southern Europe—Portugal, Spain, Italy. There’s also a clear decoupling in terms of activity between manufacturing which is in recession and services which is not. This is something of a trend globally, but it is particularly true in Europe, with Germany in a manufacturing recession. New orders and industrial production indices suggest more challenges ahead due to structural forces like energy costs, competitiveness issues, and tariff risks from the US. Germany's export engine has clearly stalled. European household consumption remains weak overall. The savings rate is very high, while employment is slowing and corporates are cutting back on investment due to sluggish demand. Finally, fiscal policies are becoming more restrictive, particularly in France, where the government's fiscal program is likely to weigh on growth in 2025.

MC: Bertrand, do you want to add anything on that point?

Bertrand Rocher: Maybe just a touch of pessimism regarding the automotive industry. Even if China reinjects liquidity, I don’t think the German automotive industry will benefit much. The Chinese market might be turning away from foreign manufacturers, and this is not the turn of German OEMs to feel it. So, while there might be some short-term gains in the course of 2025, it won’t last long, especially for the automotive sector.

MC: It is a good point to note, especially because Germany is the heavyweight within the Eurozone. What I find intriguing, however, is the contrast between Germany and Spain. How do you explain these dichotomic trends within the same zone?

DB: Spain is likely to achieve 3% real growth this year. We tend to view Spain as a service-oriented economy, particularly around tourism, and the tourism sector is performing well which has led to good growth. But, what we have seen over the past few years is the economy diversifying and fully benefiting from the recovery plans and reindustrialization efforts, including in sustainable sectors like hydrogen production and solar energy. Spain also has a positive migration balance, similar to the US, which increases its growth potential.

MC: We have a muted growth in France, and in Germany, as you mentioned. But, I think the fundamental point of differentiation is that in all Eurozone countries, including Italy—though it’s still a bit too early to draw conclusions about Italy—potential growth does not seem to be increasing or even decreasing. But, Spain, due to its migration policy, appears to recognize that including a larger working population increases an economy’s potential and thus helps resolve a growing number of issues.

Let’s address another key topic: inflation. European inflation has declined significantly over the past few months. What is your diagnosis on the price dynamics. What can we except from the ECB?

DB: A significant part of the fall in inflation across Europe has been driven by falls in energy prices which were very high one year ago and so affected the base level used for comparison. If you look deeper however inflation in goods prices and food prices has also decelerated and we expect a gradual deceleration in wages in the coming months as the labor market cools. This should allow inflation in services to normalize during 2025 as well. In this context we expect the ECB to cut rates by 25bp at each monetary policy meeting, including December, at least until next June. Housing investment is set to pick up again, as banks begin to relax their lending conditions. The most rate-sensitive sectors should benefit too. But the ECB won't be able to boost growth on its own. Other factors are at play, such as consumer confidence and the rebound in exports. 

MC: So, we might have a boost from the ECB accompanying gradual disinflation, including on the core part. If we turn now to China, do you think we could get a boost from China with the array of stimulus measures that have been announced. Once again, let’s differentiate things. To my mind, this is primarily a monetary measure, not a fiscal one. This is probably where we can’t yet talk about a "bazooka," but rather a kind of “little firework display”. But what about the most recent Chinese stimulus announcements, which are aimed specifically at the real estate sector— with the main objective of stopping real estate deflation? How do you see this impacting China first?

DB: I think it is key to acknowledge that it is significant. September politburo isn’t a date the government would typically announce such plans, which indicates that they clearly felt it was urgent. But, more importantly it does appear to be a change in narrative. Something similar to Mario Draghi’s “whatever it takes” sentiment that it will do what is required to stabilise housing prices and they are backing it up with real monetary and fiscal stimulus, with bank recapitalization and support for the housing market.

China has also room to implement a plan, because the Fed has begun its monetary easing policy. This ultimately allows for a very flexible monetary policy without scaring off foreign capital and without having too much downward impact on the yuan. I think they need to clarify what they want to do on the budgetary front and deliver quickly on what they’ve announced. We’ll see how the consumer behaves given their dependence on real estate to pay for retirement and healthcare. Will they use these checks to continue to get into debt, or will they take a step back? There are many uncertainties, so I am still in "let’s see" mode. If this plan succeeds in stabilizing real estate prices we should take this plan quite seriously.

MC: The problem with this type of stimulus is that China is cumulating all the difficulties. The supply-side stimulus, indeed, in a context of growth that is becoming more regionalized, with a globalization of trade that is slowing down and even threatened, is not necessarily a good strategy. A demand-side stimulus is exactly what needs to be done. But, as you say, the transmission channels of monetary policy to the real economy take some time. Just because they decree a massive plan doesn’t mean it will immediately flow into the economy. It takes several months to see effects, which will leave time to present a much more substantial budgetary plan, in my view, and have a more comprehensive strategy ready for 2025 to face what could also be a difficult year. I’m setting aside the American elections in this context. Ultimately, could 2025 also see a Chinese breath of fresh air pouring into the European economy? If so, how, through what channel, and which countries precisely?

DB: Some caution is needed in the sense that we’ve already had a rebound in those sectors exposed to China. We do have sectors like luxury, automotive, capital and consumer goods that are the most exposed. On one hand, there’s increasing competition in the domestic market, meaning these stimulus plans might also benefit local Chinese companies. Especially, it’s a stimulus for low-income households, which means they’ll likely consume products made in China. So there could be a reverse trickle-down effect, as we say, towards wealthier households that can consume Western products like German cars or luxury goods. But that’s still a secondary effect, and primarily, it could save the local producer. Then we also have significant trade tensions that are still very clearly present. Whether there’s a massive fiscal plan or not, we can clearly see that the trend is toward strengthening these tensions, whether Sino-European or Sino-American, regarding electric cars and batteries, wind power, solar energy, steel etc.

MC: From a macro perspective, it doesn’t add up. However, Europe has decided to try, despite its lack of coordination and its operational inefficiency, to also get involved by taxing China. They’ve already started, but will they be able to take advantage of this sort of tariff tunnel that the US opened and reinforce their desire to impose heavier tariffs on China? Do they have the means to do that? It’s something new, and we have very little perspective on it. The Americans are capable of anything, as we know. Do the Europeans have the means to support their tariff and protectionist ambitions?

BR: Germany, Hungary, and Spain have opposed such tariffs but the European Commission presses ahead with its intentions to hit Chinese electric vehicles. Although these are not as harsh as those in the US. because Americans can afford 100% tariffs. They aren’t really threatened by Chinese cars at the moment, but Europeans certainly are. And the paradox is that the Germans want to preserve their strongholds in China, hence their margins as the sales volumes they record there help them amortize their development costs on a far larger basis than if they had to rely on the European markets only. I think we can already prepare for the European front to waver in the face of Chinese products. We’ve seen it, right? They threaten cognac, Spanish ham etc. But the real measure of retaliation is to continue blocking de facto the market for Porsche, Mercedes, BMW, and to a lesser extent, Audi. And then there’s Volkswagen, which has been the leader there for 30 years…

MC: Aren’t we still dependent on China? US tariffs in 2018 increased Europe’s dependence on China. Aren’t we at risk with this tariff policy, or retaliatory measures that would be more damaging for us than for the US?

DB: It’s always a question of willingness. Are we willing like the US to reinternalize production? With massive stimulus plans and Germany exiting the golden rule’ (only borrow to invest), in the medium to long term, that could be a way to re-industrialize and raise our potential growth. Or are we, in fact, continuing with this political dislocation? Are we facing a situation where China and the United States will take advantage of weak links to divide us.
If that’s the case, we’ll loose on all fronts since we won’t reindustrialise and we’ll continue to deal with the Chinese and American pressure. The outcome of political elections, especially in Germany, is crucial to how we build Europe, whether we are united or not against our competitors.

MC: This echoes Draghi’s recent report, calling for more investment on a European scale. We’ve seen it’s possible to unite and respond to crises, like during COVID. But unfortunately, Europe moves forward with its back against the wall.

BR: The US wants Europe, especially Germany, to choose. Germany’s primary market from 2015 to mid—2023 was China, the second was the US, but it’s now back into the first seat for a few quarters. Trump’s first term aimed to end Germany’s strategic and commercial ubiquity. The Biden administration has not changed that approach very much. In the end, it means we don’t have the means to cut ties with China economically, but the US strongly encourages us to do so.

MC: Well, this reminds me a bit of game theory, doesn’t it? That is, the optimal balance requires cooperation, which we no longer have. Whichever choice we make will be suboptimal. That’s the position Germany finds itself in.

BR: Basically we are cornered with the adjustment variable of Sino-American ties; we’re the ones who will suffer for it. We're not very optimistic for France, Belgium and Germany, David and I, in the end, because it all comes back to saying that we’re the ones facing shocks instead of the other two. That said, there are ways out if we show a united front, coming back to Draghi’s report.

MC: Yes, being cornered by several external constraints, the best thing is to revitalize our growth potential. The Americans have demonstrated this. With almost 3% growth last year and between 2.5% and 3% this year, despite ultra-restrictive monetary policy, the budgetary side has functioned well. If we don’t do this effectively, we will be condemned to structural decline.

DB: We have a size difference with the US, we don’t have the US dollar. But there is a weapon in Europe we’re not using compared to the Americans—massive savings rates that could raise our potential growth. We need to better direct savings in Europe, even if it means state backed projects which consumers could otherwise find too risky to fund their retirement for instance. This could help finance future challenges in defense, digital transition, energy transition, re-industrialization, automation, and more.

MC: That’s a huge topic and I would suggest it is a rather optimistic way to end. Thank you both for this insightful discussion. It’s clear that while challenges abound, there are also significant opportunities for Europe to strengthen its economic position.