European Macro Outlook: What's in a Number?

CUSHMAN & WAKEFIELD RESEARCH European Macro Outlook

ECONOMY

However, despite the overall rate of inflation slowing for the euro area and the UK, food price inflation remains very high. Food price inflation was 16.3% YoY in January in the euro area and 16.7% YoY in the UK. Food and non-alcoholic beverages make up a large proportion of consumption baskets across the euro area. For example, food accounts for around 20% in Italy and 22% in Spain, thus food prices will remain a source of inflationary pressure for the first half of 2023. Higher, Stickier Underlying Inflation? A downside risk associated with inflation could stem from tight labour markets. High inflation accompanied with tight labour markets keeps wage inflation elevated, potentially causing a “wage price spiral,” where inflation leads to higher wage growth and fuels even higher inflation. While most agree that a wage-price spiral is not happening now, the fear is that it could occur should inflation expectations de-anchor. In line with this view, wage growth across the euro area and the UK is slowing, moderating in the fourth quarter for the UK (5.9% from 6.2%) and slowing in the third quarter in the euro area (2.9% from 3.8%). Wage growth has averaged 2.7% for the UK and 1.9% for the euro area over 2015-2019. A robust labour market is one of the key factors that will keep the recession relatively mild across the euro area and the UK. However, labour markets tend to be a lagging indicator, which is why we expect the impact of the mild recession to begin showing in the labour markets in H2 2023. Job vacancies are leading indicators to labour market developments and recent data indicates that the market is cooling. The number of job vacancies in the UK has fallen for six consecutive quarters in

the third quarter (-6.1%), while the growth in job vacancies has eased from 3.2% to 3.1% in the euro area. Although job vacancies remain above pre pandemic levels, these are early signs of the job market abating. The weakening activity toward the end of 2022 is likely to start showing up in labour market numbers by H2 2023. Bond Yields on a Better Footing Last year was not a particularly good year for sovereign bond yields. Bond markets witnessed one of the sharpest selloffs on record, triggered by high inflation and a series of interest rate increases. Longer-term sovereign bond yields have been acutely sensitive to interest rate changes at the short end as well as forward guidance issued by central banks, as policymakers shifted their entire focus to taming inflation rather than supporting markets. Following a turbulent year, we believe bond yields will start off 2023 on a better footing. Inflation is beginning to ease, with markets anticipating interest rates to peak in the coming months. Challenges are still ahead, particularly as economic activity is expected to remain low. Despite the interest rate hikes to come, bond yields are expected to finish the year only marginally higher than in 2022. Any recession, albeit mild, poses a challenge for both occupiers and investors. But our view is that with disruption comes opportunity. The repricing seen across financial and real estate markets in H2 2022 has improved prospects for returns in the coming months. Of course, all real estate is intensely local, and there will be certain sectors and geographies that will outperform and others that will underperform. In the year ahead, occupiers of real estate and investors are likely to be rewarded as growth begins to gather momentum.

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