Economic and financial outlook 2023

Peter Vanden Houte

Peter Vanden Houte

Chief economist ING

Steven Vandepitte

Steven Vandepitte

Investment office ING

Will the economic situation improve in 2023? Has inflation peaked? Will rate hikes continue to weigh on the markets? Check out our experts' answers to these questions.

After the recession comes the recovery, but the handbrake will be kept on

Although the recession is not expected to be very deep, the fear is that the recovery will be weak in 2023, especially in Europe. Indeed, a number of factors will keep the handbrake on as the recovery arrives. Energy prices for example are likely to remain high in Europe throughout 2023. And since central banks will continue to raise interest rates during the recession, interest-rate-sensitive sectors will not be fuelling the recovery. Moreover, it is unlikely that European governments will be able to maintain their current fiscal generosity throughout the year.

"Energy prices are likely to remain high in Europe throughout 2023"

Philippe Ledent, senior economist, gives his economic forecast for 2023. (in french)

Economic stagnation in 2023... at best

With growth expected to be 0.1% in the US and -0.3% in the euro area and Belgium, this will be a year of recession, even though the second half of the year is likely to see a return to growth. For China, the GDP figures do not really reflect the economic situation. But we are seeing that economic stimulus and support for the housing sector are on the increase. The biggest problems with Covid-19 should be over by the summer, enabling the economy to grow at a faster pace again. This is not necessarily good news for everyone. China will indeed start importing more raw materials and energy, which will also keep natural gas prices in Europe, along with other commodities, at high levels.

Inflation has peaked

Inflation now seems to have peaked. Indeed, although energy prices remain high, the contribution of energy to the inflation rate is falling. Commodities prices and transport costs have already fallen considerably, while high inventories are also a brake on inflation in the prices of goods. Inflation will certainly be lower in 2023, but the decline in core inflation in the euro area will probably be slow. Wages are rising and in the first months of the year we still expect significant price increases in those sectors that only make adjustments once a year. In the services sector too, the fall in inflation will be slow. As a result, inflation will probably still be above 3% in the euro area at the end of 2023. At the same time, the US could already be closer to 2%. 

"Inflation will certainly be lower in 2023, but the decline in core inflation in the euro area will probably be slow."

Short-term interest rates rise further

Despite the growing threat of recession, major central banks will continue to raise interest rates for some time to come due to high inflation. In the US, the Fed will only stop tightening when interest rates reach 5%. The ECB is also continuing to raise interest rates: the deposit facility rate is expected to reach 3% at the end of the first quarter, i.e. 100 basis points higher than at the end of 2022, and it cannot be ruled out that it will rise further to 3.5% in the second quarter. At the same time, the ECB will start to reduce its bond portfolio. While the ECB will still not be able to take its foot off the monetary brake in 2023 due to more persistent inflation, a first cut in US rates before the end of the year seems plausible.

Limited upside potential for long-term interest rates

Long-term interest rates are, as always, ahead of short-term rates, so the potential for further increases seems more limited. Nevertheless, the already significant rise in interest rates, combined with the contraction of the economy, is bad news for companies and governments with large debts. In addition, the risk premiums of the weaker players also threaten to increase somewhat. Finally, the dollar remains expensive, even after its recent correction. Some upside potential therefore remains for the euro. But because of the still difficult energy situation in Europe, a more significant strengthening of the euro is unlikely to happen before 2024. 

Investment strategy: Preference for defensive equities and investment grade bonds

The stock market (as represented by the MSCI World All-Countries index) has experienced several violent rallies this year (over 4% in euro terms), but each time these rallies have deflated and finally fallen to new lows. Three of these rallies did record gains of 10-17%, but this did not enable the index of major world stocks to exceed its previous high, which could have been interpreted as a sign of the end of the downtrend or even the beginning of a new bull market. Historical analysis tells us that rallies in a bear market can be short-lived and give the false impression that a trend change is underway.

Luc Charlier, investment strategist, gives his investment recommendations for 2023. (in french)

Equity valuations do not necessarily mean they're a good buy

Last October, at the bottom of the market, the S&P 500 was trading at 17.3 times earnings. After rebounding by about 14% since mid-October, the ratio now stands at 19.9. Remember that when the Fed raised rates to 5% or more in previous tightening cycles, the median price/earnings ratio of the S&P 500 bottomed out at 15.3. 

"Equity investors - used to ultra-low rates - have not yet fully integrated the change in rates and the new economic situation."

Maintain a defensive profile...

Considering how far the markets have come, valuations and the risks and opportunities present, we maintain a preference for a defensive bias by overweighting defensive stocks, particularly those with low volatility and high dividend yields (such as healthcare) and value stocks (such as financials). 

... and a preference for investment grade bonds

With bonds having undergone significant rerating - high yield and investment grade bonds are on track for a historic 8% correction (in euro terms) in 2022 - they now appear to have priced in much of the ongoing monetary tightening cycle. The "TINA" (There Is No Alternative) phenomenon, which has dominated asset allocation in recent years and favoured equities over bonds, is clearly no longer relevant. Bond yields are again more attractive, both in absolute terms and relative to the dividend yield from equities. In this context, we maintain our preference for investment grade bonds over high yield bonds. In the coming year, investment grade bonds should be able to provide a reliable source of diversification from equities should a recession materialise. They now offer an average yield of close to 3.5%, which at the end of 2021 was only available from high yield bonds.

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