China's growth outlook has weakened because of a persistent property downturn and low consumer and business confidence. Despite this, policymakers are refraining from significant macroeconomic policy easing, especially on the fiscal front, leaving the economy vulnerable to downward pressure on prices and profit margins.

Meanwhile, Asia-Pacific growth remains largely intact, driven by a continued export recovery and, in most emerging markets (EMs), solid domestic demand. Regional central banks are unlikely to cut rates aggressively because of relatively low interest rates compared with the U.S. and domestic considerations such as high house prices and high debt.

U.S. And Europe: Interest Rates Are Falling

A softening of inflation and the labor market prompted the U.S. Federal Reserve to start cutting rates sooner than we expected three months ago.  Following the 50 basis points (bps) September cut, we expect another 50 bps decline this year, and we now see the policy rate reaching its so-called terminal level of 3.0% to 3.25% in late 2025. We expect the eurozone to reach the terminal level of 2.5% in the third quarter of 2025.

Our base scenario suggests a soft landing for the U.S. and Europe.  Our growth projections for these economies remain largely unchanged. We anticipate U.S. GDP growth will average 2.7% in 2024 and 1.8% in 2025. We see eurozone growth picking up to 0.8% this year and 1.3% in 2025.

China: A Soft Growth Outlook Amid Downward Pressure On Prices

Economic momentum has slowed amid the persistent property downturn and weak confidence.  Quarterly GDP growth slowed to 0.7% in the second quarter, and to 4.7% on a year-on-year basis.

Key economic indicators suggest a soft third quarter.  Export growth has remained strong. But slow growth in retail sales reflects weak consumer confidence and a trend toward cheaper products (see chart 1). Investment momentum has slowed amid the real estate slump and weaker investment growth in other sectors. In all, industrial production growth slowed in the first two months of the third quarter.

Weak domestic demand is weighing on prices and profit margins.  The GDP deflator fell 0.7% in the second quarter. Core inflation dropped to 0.3% in August, housing prices are falling, and there appears to be downward pressure on wage growth.

Despite the muted outlook, policymakers have refrained from meaningful policy stimulus.  The People's Bank of China (PBOC) reduced policy interest rates modestly in July. Given the lower U.S. rates, we now expect another 10-basis point rate cut this year. We also see some policy efforts to encourage credit growth. Given the low confidence and pressure on prices, fiscal stimulus would be more effective in buoying growth than modest monetary easing. Yet, fiscal expenditure lags the 2024 budget allocation, bond issuance has been slow, and there are no signs of substantial fiscal stimulus plans.

We have reduced our 2024 GDP growth projection to 4.6%, from 4.8%, to reflect the weak domestic demand outlook.  We see 4.3% growth in 2025, from 4.6%.

The PBOC has increased control over short- and long-term interest rates.  It wants to keep the seven-day reverse repo rate--a strong candidate to become the policy rate--in a narrower corridor than before and has added operations to its toolbox to achieve that. In addition, the central bank now has a mandate to intervene in the government bond market if it considers market developments inappropriate. It recently intervened with transactions to contain a decline in government bond yields, stemming from the weak growth and inflation outlook (see chart 2).

Domestic and external risks persist.  Real estate activity could be even weaker than we expect. The risk of problematic systemic deflation--when falling prices and wages reinforce each other and drag down economic activity--has risen. In the short term, say the next six months, the main external risk is slower global growth. In the medium term, it is accelerated supply-chain adjustment and large barriers to trade and investment by major trade partners.

Chart 1

Chart 2

China's share in global exports has held up in recent years (see "Slow-Motion Shakeup? Asia's Role In Global Supply Chains Is Slow To Change," published on RatingsDirect on Aug. 27, 2024). But rising geopolitical friction, trade barriers, and industrial policy will test its economy.

Asia-Pacific Growth Is Mostly Holding Up

The key factors driving our growth forecast remain in place, pulling in opposite directions.  

• Asia's export recovery is continuing (see charts 3 and 4). This is supporting growth, directly and indirectly, via stronger investment.
• Elevated interest rates and inflation are weighing on spending power in several developed economies.
• In most EMs, the restrictive monetary stance hasn't hurt domestic demand much because credit growth has remained solid.

Chart 3

Chart 4

Economic growth has largely adhered to our expectations. We see mostly solid growth, especially in the Asian EMs. 

In India, GDP growth moderated in the June quarter as high interest rates temper urban demand, in line with our projection of 6.8% GDP for the full fiscal year 2024-2025. The July budget confirmed that the government remains committed to fiscal consolidation and to keeping the focus of public expenditure on infrastructure.

Japan's GDP grew solidly in the second quarter, from the first. Household consumption was weak in the first half of 2024 as inflation weighed on real incomes. But rising wage growth is starting to bring improvement on that front. We have revised down our forecast for 2024 GDP growth by 0.6 of a percentage point, but that is largely because of statistical revisions to historical data. We expect significant growth in the coming quarters.

In Australia and New Zealand, elevated interest rates and inflation continue to weigh on consumption and investment. In Australia, a resilient labor market and strong immigration mean that GDP growth has remained positive. We have nudged down our 2024 GDP growth forecast but slightly raised the 2025 projection. In New Zealand the labor market is weaker, and unemployment has moved higher. The most recent readings suggest a sequential improvement in consumer and business confidence, which may indicate a gradual bottoming out of economic conditions.

In South Korea and Taiwan, quarter-on-quarter GDP growth slowed in the second quarter following an export-led growth spurt in the previous quarters. In both cases, the slowdown stemmed from softer domestic demand. We slightly lowered our 2024 growth forecast for South Korea. But we revised it up for Taiwan, and in both economies we see an acceleration compared with 2023.

Southeast Asian growth has remained generally solid, benefiting from the export recovery and robust domestic demand. We have revised up our growth forecasts for Malaysia, Singapore, and Vietnam. The Indonesia outlook remains unchanged. We have reduced it for Thailand, now assuming less expansionary fiscal policy, and nudged it down for the Philippines.

In all, we project 4.4% GDP growth in 2024 in Asia-Pacific, compared with 4.5% three months ago. We see the region expanding 4.4% again next year.

Key growth risks are the U.S. slowing more sharply than we expect, lower growth in China, and weaker domestic consumption.

Regional Rates Won't Come Down As Fast As In The U.S.

The start of rate cuts by the Fed has brought relief to regional foreign exchange markets.   Many Asia-Pacific exchange rates have gained significantly against the U.S. dollar so far in the third quarter (see charts 5 and 6).

Chart 5

Chart 6

Inflation pressure has receded, except in Australia and India. 

Regional central banks have nevertheless generally refrained from lowering policy rates.   The Philippines, New Zealand, and Indonesia have been exceptions; rate setters there have recently agreed on cuts of 25 bps.

Many central banks will start cutting rates later in 2024 but it will be gradual.

• Interest rate differentials with the U.S. remain uncomfortable. Policy rates are below those in the U.S. in all economies except India, Indonesia, and the Philippines (in Hong Kong they equal U.S. rates because of the strictures of the currency peg). While the gaps are particularly large in Japan, Taiwan, and China, across the region rates are historically low compared with the U.S. (see charts 7 and 8).
• Despite the recent strengthening, currencies remain weak compared with historical trends and fundamentals (see Asian Emerging Market Currencies Will Chart A Comeback, Feb. 26, 2024).

Chart 7

Chart 8

• In several economies domestic considerations add to the caution on rate cuts. In addition to the generally favorable growth outlook, in some economies these considerations include house price increases and/or elevated debt.

In this setting, other than in China, Indonesia, and the Philippines, we have not advanced our forecast for policy rate cuts, compared with our June outlook.  Meanwhile, with the U.S. interest rate cut projections advanced and the domestic rate outlook unchanged, we now generally expect currencies to be stronger against the U.S. dollar than we did three months ago.

In India, solid growth allows the Reserve Bank of India (RBI) to focus on bringing inflation in line with its target.  The RBI considers food inflation a hurdle for rate cuts. It reckons that unless there is a lasting and meaningful decline in the rate at which food prices are increasing it will be tough to maintain headline inflation at 4%. Our outlook remains unchanged: we expect the RBI to begin cutting rates in October at the earliest and have penciled in two rate cuts this fiscal year (year ending March 2025).

We expect the Bank of Japan (BOJ) to gradually lift its policy rate in coming years because the outlook for sustained inflation of about 2% has improved.  The BOJ lifted the policy rate by 15 bps to 0.25% in July. Importantly, there are signs that the robust spring wage negotiation results are starting to feed through into overall earnings growth. We see wage growth rising further in the coming 12 months, supporting consumption growth and thus strengthening the case for further rate hikes. The BOJ will also start to taper purchases of government bonds.

In Australia, sticky inflation will prevent rate cuts any time soon.  While economic growth has slowed, the Reserve Bank of Australia (RBA) estimates that overall demand in the economy still exceeds supply. Indeed, consumer inflation rose to 3.8% in the June quarter, from 3.6% in the March quarter. Changes in administered prices and subsidies will reduce headline inflation in coming months but increase it in 2025. The RBA forecasts 3.7% inflation by end-2025; we a bit more. Against that backdrop, we maintain our forecast that the RBA will leave the policy rate unchanged in 2024 and cut it by 50 bps in 2025, even as current market pricing implies much larger rate cuts through end-2025.

As the Fed cuts rates, Asia-Pacific is weighing its options. Rates in the region won't come down as fast as in the U.S.

Related Research

• Slow-Motion Shakeup? Asia's Role In Global Supply Chains Is Slow To Change, Aug. 27, 2024
• Paving The Way: Efficient Infrastructure Key To Emerging Asia's Growth, July 25, 2024
• Asian Emerging Market Currencies Will Chart A Comeback, Feb. 26, 2024

Table 1

Table 2

Table 3

Table 4

Table 5