EU inflation is surprising everyone who helps its economy catch up with the US

For a long time it has felt like a fact of life that the US economy outpaces that of Europe. The divergence has become more pronounced recently, as America’s biggest industries seem to have taken the leap toward major technological advances like AI.

Across the water, Germany, Europe’s largest economy, has been stuck in limbo, while the continent’s workers have faced accusations that they simply aren’t ambitious enough to keep up with their American counterparts.

But Europe’s bulls may finally be rewarded for their patience, as a growing number of analysts are betting the EU will close the gap.

Unexpected good news

Rajeev Sibal, a global economist with Morgan Stanley, said banks’ expectation was that the EU economy would accelerate this year.

And after months of dismal growth, export and manufacturing figures in its biggest economies, the continent could be in for some much-needed good news on the monetary policy front.

Eurozone inflation fell to 2.4% in March, with expectations for a similar level in April. Meanwhile, in the US, prices rose 3.5%, well above both central banks’ 2% targets.

Europe has therefore been able to be bolder with its monetary policy compared to the US. inflation.

It was the first time this century that the Swedish Central Bank had moved ahead of the Fed to cut interest rates.

In the Eurozone, one of the reasons we have this divergence between the Fed and the ECB is because Eurozone inflation is clearly trending lower and closer to target, Sibal said. And I think that the trend in the Eurozone affects the decision-making of many central banks in the region.

A tight US labor market, on the other hand, makes it harder for policymakers to cut rates.

The effect of the delay of that restrictive monetary policythe federal funds rate has remained at its highest level in more than 23 years since last summerit’s starting to tap into the resilient American shopper.

Sibal indicated that the long-term divergence between the US and Europe was set to close in the second half of 2024 as the EU becomes more competitive.

We expect the US consumer and labor market to start showing further signs of slowing, Sibal said. Eurozone consumers, on the other hand, are seeing real incomes rise as inflation cools, which is supportive of private consumption.

According to the OECD, the US is still expected to outpace Europe this year, growing by 2.6% compared to 0.7% in the Eurozone. But a monetary policy divergence is drastically changing the rules of engagement.

Swiss bank UBS is even more positive about Europe’s chances of outperforming the U.S. In a note last week, UBS Investment Bank strategist Andrew Garthwaite said that based on indicators he tracksincluding PMI data, excess savings and monetary policyEurope’s GDP carried upside risks, meaning it was more likely to beat growth expectations.

The bank says the US, meanwhile, carries downside risks.

As a result, UBS decided to make a U-turn, with European shares (excluding the UK) outperforming US stocks in its regional scoreboard.

It echoes Goldman Sachs’ bullish bet in March on a group of European stocks called Granolas, which the bank said were able to take on the much-vaunted US Magnificent 7 stocks.

Problems remain

Despite signs that Europe will begin to catch up with the US in the second half of the year, there are still many known obstacles that could prevent it from catching up.

One of them is bridging a growing productivity gap between the two regions.

European productivity, or output per worker, has lagged behind the US for some time, but has really lagged since the start of the global financial crisis of 2007-2008.

Erik Theden, the man who oversaw the ambitious Swedish rate cut, admitted that Europe needed to improve its productivity levels to catch up with the US.

There are several factors that may have contributed to this gap, with some academics blaming Europe’s failure to invest in the knowledge economy in the 1990s.

In a US-focused analysis, Morgan Stanley said the spread of artificial intelligence and a tight labor market have been boons for US productivity in recent years as well. However, it has not carried out a comparative analysis with Europe.

But underlying the productivity debate is the controversial perception that Europeans simply don’t work as hard as Americans.

Talking to Financial Times in April, Nicolai Tangen, CEO of Norway’s $1.6 trillion oil fund, said there was a difference in the overall level of ambition between Europeans and Americans.

We are not very ambitious. I should be careful to talk about work-life balance, but Americans just work harder, Tangen said.

Whatever that perception, Europe can feel a warm feeling this summer, knowing that for once it may not be the weakest economy in the world.

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