The Italian confidence data framework remained mixed again in December, confirming the lack of a clear direction. Confidence weakened again among consumers and, on the business front, in manufacturing and construction, and improved in services.

Consumers increasingly concerned by economic developments and future unemployment

Consumer confidence has declined for the fourth consecutive month, driven by growing concerns about the future economic situation and future unemployment. The unemployment index has reached its highest level since November 2022. While consumers are not yet indicating a significant negative impact on household finances, they are becoming less willing to purchase durable goods. This trend is a warning signal for consumption patterns in 2025. We maintain the assumption that private consumption will be a key driver for GDP growth next year, based on the continued resilience of the labour market. However, if employment weakens, the risk of a negative surprise in consumption will increase.

Manufacturers report softening orders and increasing inventories

On the business front, the renewed weakening of manufacturing confidence is not surprising, given the recent developments in the external backdrop. In December, confidence was dragged down by a further softening in order books, both domestic and foreign, and by weaker expectations for economic developments. Manufacturers are signalling a marked increase in inventories, and a growing intention to reduce the workforce. The overall interpretation of these signals suggests that the conditions are not yet favourable for an end to the two-year-long manufacturing recession. Manufacturing has likely continued to hinder growth in the fourth quarter and is expected to remain weak in the first quarter of 2025.

Construction sector confirms divergence between dwellings and infrastructure

In the construction sector, confidence unsurprisingly fell on the month, reaching the lowest level since November 2022. Admittedly, the decline remains very gradual, despite the end of the generous Superbonus incentive. Two forces are likely at play here: a residual effect of the incentive as projects are being completed, and some momentum from the non-residential component as recovery fund money is being spent. The good news is that firms in the dwelling sub-sector do not signal any intention to reduce their workforce.

Services the bright spot, a candidate growth driver

The obvious bright spot in the confidence data is the service sector. After falling in November, confidence rebounded solidly in December, propelled by solid gains in information and communication and services to businesses, and by further improvements in tourism. Confidence in the retail sector confirmed recent gains, with assessments of current sales and expectations of future sales reflecting this positive trend. The service sector looks thus set to remain the growth driver of the Italian economy, at least in the short run.

Italian economy still in a soft patch as the year ends

The release confirms that the Italian economy ended the year in a soft patch. Whether it manages to post small positive quarterly GDP growth, which remains our base case, will depend on how well services can compensate for manufacturing weakness. This is likely to remain the main theme over the first part of next year. For the whole of 2025, given the likely backdrop of soft export demand, Italy's growth performance will likely depend on two factors: private consumption and the actual spending of recovery funds, where progress has been slow. We currently expect Italian GDP growth to be 0.7% in 2025 (from 0.5% in 2024) and see very limited room for upward surprises.

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Canada – Capping the Year Off with a Bang

What a year last week was! The show stealer was Minister Freeland’s surprise resignation the day she was set to deliver the Fall Economic Statement (FES). What’s more, the Canadian dollar fell below the psychological 70 U.S. cents mark (as of writing), weighed down by the prospect of a slower pace of U.S. rate cuts.

Amid the federal government chaos, the FES was tabled (see here). As expected, the Liberals blew through one of their self-imposed fiscal guideposts (FY 2023/24 deficit was $60 billion, a 50% miss relative to the guidepost), but could still hit the other two (declining net debt-to-GDP and a deficit-to-GDP ratio below 1%). Even with one of these guideposts missed, the reality is that Canada’s fiscal position is strong relative to its international peers and the federal government maintains its a AAA rating on its debt.

About $20 billion in net new measures were announced in the update, including $18.4 billion to extend the accelerated investment incentive and immediate expensing measures (under the capital cost allowance rules) that were due to be phased out. These measures have lowered the marginal effective tax rate on investments by 3.1%, on average. The government will also spend $1.3 billion on border security to ease President-elect Trump’s concerns. The GST holiday is slated to cost $1.6 billion, and we envision it offering a marginal lift to economic growth in early 2025, but not enough to significantly move the dial. For the Bank of Canada, there was probably not much in the FES to significantly alter their thinking on monetary policy. However, Canada’s fiscal situation is worse off than what was expected in the spring (Chart 1), offering less space to offset negative economic developments.

On the data front, home sales posted a firm gain in November, and benchmark home prices jumped 0.6% on the month. That’s likely to catch the Bank of Canada’s attention given the upside potential for shelter cost inflation. Homebuilding was also solid last month, with starts climbing 8%. However, they continue to retrench in Ontario, which is the market that can least afford a slowdown given affordability challenges. On the softer side, retail sales volumes were flat in October (and could be again in November), although this followed hefty monthly gains in the prior three months.

November’s inflation report was the marquee release of the week. Overall inflation dipped to 1.9% in November. However, the Bank of Canada’s core inflation measures stalled at 2.7%. Also concerning was a back-up in shorter-term metrics. The 3-month annualized change in core inflation pushed above 3%, and the less volatile 6-month trend points to further upward pressure in 12-month core inflation ahead (Chart 2). These trends are certain to unsettle policymakers and support the Bank of Canada’s position that it will be more patient on future interest rate cuts. We think the Bank will proceed more slowly in 2025, with one 25 bps cut per quarter (see our updated Quarterly Economic Forecast). However, the U.S. tariff threat makes the outlook for the economy, and monetary policy, highly uncertain.

U.S. – Fed Signals a More Cautionary Stance on Rate Cuts Next Year

The Federal Reserve delivered some sour candy to cap off 2024, cutting its policy rate by 25 basis points, but signaling a more moderate pace of cuts next year. This hawkish tilt sent Treasury yields higher, with the 10-year rising from just under 4.4% to briefly over 4.6%. Equity markets took the news hard, with the S&P 500 down roughly 3.5% from pre-meeting levels at time of writing. Part of the weak equity market performance may also have to do with a looming government shutdown. Washington has only a few hours to pass a funding bill into law. Failure to do so will lead to a partial government shutdown. Essential services would continue, but most federal workers wouldn’t receive a paycheck. In addition, some workers would be furloughed until Congress passes new funding. The Bipartisan Policy Center estimates that some 875 thousand federal workers would be furloughed.

The Fed’s quarter point interest rate cut was as expected, but the accompanying Summary of Economic Projections (SEP) raised a few eyebrows. While the median forecasts for economic growth and the unemployment rate were little changed, the outlook for inflation and the policy rate were raised noticeably (Chart 1). Focusing on the year ahead, the median projection now has the Fed Funds Rate ending next year 50 basis points higher than expected in September. This is in tune with a firmer outlook for core inflation. Asked about the more cautious stance on rate cuts, Fed Chair Powell listed several reasons. These included the economy growing at a better pace and inflation coming in a bit hotter than expected recently. Powell also highlighted an elevated uncertainty around the inflation projections – a theme that was visible in the SEP document, with uncertainty and upside risks to core PCE inflation both up noticeably since September. Pressed on how much of the difference could be explained by the evolving data versus potential policy changes from the new Trump administration, the Fed Chair acknowledged that some policymakers did take preliminary steps to incorporate “highly conditional estimates of economic effects of policies into their forecast at this meeting”.

Last week’s economic data buttressed several of Powell’s comments. The third estimate of Q3 GDP indicated that the economy grew at an improved pace of 3.1% annualized, up from 2.8% previously. At the same time, the November personal income and spending report indicated that consumer spending should end the year on solid footing. Consumer spending is on track for a solid 3% pace in the fourth quarter of 2024. That is only a small downshift from 3.5% pace in the third quarter. The November report also carried some better news on inflation, with the Fed’s preferred inflation gauge – core PCE – cooling noticeably in November, up a modest 0.1% month-over-month. While the annual pace remained at 2.8%, this latest cooldown helped reverse near-term trends lower (Chart 2).

Overall, with the economy remaining on decent footing and inflation seemingly having resumed its downward path, there is room for further policy normalization next year. But, the potential for major policy changes from the new U.S. administration remains a wildcard.

The U.S. dollar ends the year on a strong note, hitting two-year highs at 108.45. The Fed expects a 50-point rate cut for the full year 2025 versus 4 cuts one quarter earlier, citing higher inflation forecasts and a stubbornly strong labour market. This fundamental change has given a new impetus to the dollar’s rise that began in late September.

The fundamental reason is the change in the tone of the Fed’s monetary policy. Two consecutive 25-point cuts followed a 50-point cut in the key rate in September. Recent comments suggest a pause in January. The difference between current expectations for the end of next year and what was priced six months ago exceeds 100 points. Meanwhile, the euro, pound, and yen have much more modest six-month changes in expectations. Until September, this difference was against the dollar, but now it is becoming the driving force behind it.

The dollar’s strength is also the result of market speculation, expectations of intensified tariff wars, and fiscal stimulus expected from the Republican Party’s dominance of US politics since November. There has been no actual change yet, but there are signs that the Fed is beginning to incorporate these expectations into its policy.

The dollar index’s technical picture on the long-term charts is on the side of the bulls. Dollar buyers came in on the downturn under the 200-week moving average, turning the market up. In 2022 and 2014, the DXY rallied more than 20% after pushing off that line before consolidating. In 2019-2020, the opposite was the case, with a steady return to the mean culminating in a failure in the second half of 2020.

On the daily timeframes, DXY broke out to new highs after a corrective pullback of a couple of per cent, correcting to 78.6% of the upside from the October lows. A strong reversal to the upside proved the strength of the buyers, and exceeding the last peak confirmed the bullish bias. The next upside target looks to be the 112 area, which will be the exit to the 2022 highs.

In the context of EURUSD, the strengthening of the dollar brings it to the parity area. History suggests that the 1.0 level is unlikely to be a turning point. Either we see attempts to prevent a prolonged decline under 1.05, or buyers will emerge much later.

The tradition of central banks hosting meetings just before Christmas continued this year with policy decisions in the US, Japan, UK, Norway, and Sweden. The largest present came from the US Federal Reserve in the shape of a significant hawkish surprise. Fed cut the policy rate target by 25bp to 4.25-4.50% as expected, but Powell delivered a clearly hawkish message, highlighting that the easing cycle has entered a “new phase” in which the Fed is looking to slow down the pace of rate cuts. The updated “dots” now project only two 25bp cuts next year compared to four in the September projections. The main reason for the hawkish turn was an upward revision of the inflation forecast to 2.5% y/y in 2025 (from 2.1%) and the fact that most members even saw upside risks to the new inflation projections. The decision pushed the entire UST curve up by some 13-15bp, and the market is now pricing only 40bp worth of cuts from the Fed next year. Due to the change in guidance, we have removed our expectations for a cut in January but continue to expect four cuts next year from March.

Both the Bank of Japan and Bank of England left their policy rates unchanged at 0.25% and 4.75%, respectively, as broadly expected. As the economic recovery looks on track, we expect the BoJ to hike the policy rate in January. The BoE delivered a dovish vote split but continue to signal a gradual cutting approach. We expect the next cut in February and a quarter pace thereafter. 

On the data front, the December PMI surveys gave some relief for the growth outlook as services PMIs rose more than expected in both the US, euro area, and UK. Services PMIs bounced back above 50 in the euro area following the large decline in November in a sign that activity is holding up while the US services PMI rose even further to 58.5 from 56.1. In contrast to the services sector, activity in the manufacturing sector weakened with US manufacturing PMI declining to 48.3, the UK to 47.3, and the euro area remained unchanged at 45.2.

On the political front, the risk of a government shutdown in the US increased this week as president-elect Donald Trump told republican congressmen to not support a stopgap funding bill that was otherwise set to pass Congress. With no other plan ready, the government is again facing a risk of a shutdown, less serious for the economy than in 2018, but still an unpleasant Christmas present for public workers.

In the coming weeks focus will be on the US jobs market report and ISM survey, euro area inflation, and Chinese PMIs and PBoC rate decision. We expect US nonfarm payrolls growth to slow down to +170k (from +227k), a steady unemployment rate at 4.2%, and average hourly earnings growth at +0.3% m/m SA. We expect euro area HICP inflation to rise to 2.4% y/y in December from 2.2% in November. The increase is mainly due to base effects on energy and food inflation while we expect core inflation to decline from 2.7% y/y in November to 2.6% y/y. In China, we expect the PMIs to be unchanged in December following increases in the past two months. Manufacturing activity is currently underpinned by some front loading of exports to the US in anticipation of tariffs next year. The PBOC will also announce its policy rate, which is expected to be left unchanged.