The global economy is being battered by weaker growth, soaring inflation, and rampant central bankers. Recession risk abounds, with the eurozone looking most exposed, given its links to Russian gas supplies. Can any leading economy avoid a “hard” landing?
The toxic combination of a de-anchoring of inflation expectations, concerns over energy security, and a sharper slowdown in China, has substantially increased the risks around the economic outlook.
Price pressures have proved to be far more ferocious than previously forecast, compelling central bankers to tighten policy rates both earlier and more aggressively than had been anticipated. This mixture of surging inflation and tightening financial conditions has led to a slump in business and consumer confidence.
After an expected contraction by the global economy in the second quarter (Q2), we have been forced to slash our growth estimates for many of the major regions for this year, and now expect the global economy to expand at just 2.8% in 2022.
While we have clearly become more sanguine on global growth prospects, we acknowledge that labour markets remain robust, consumers and corporate balance sheets still look healthy, and the service sector continues to have plenty of room to recover. We maintain the view that if the global economy should dip into recession, it will likely prove to be relatively shallow and short-lived.
Inflation to peak in the coming months
Given the scale of the pandemic stimulus packages and the unleashing of pent-up demand as economies reopened, we were acutely aware that inflationary pressures would materialise. The ramifications of the war in Ukraine on commodity markets and the impact of Chinese COVID-19 restrictions on supply chains have multiplied the magnitude of these pressures to multi-decade highs. We now anticipate that global consumer prices will average 6.6% this year, compared to 3.2% in 2021.
Nevertheless, we expect inflation to peak over the coming months as tighter monetary policy moderates demand, commodity prices stabilise, inventory levels improve, and an easing of restrictions plus increase in capacity help to resolve supply constraints.
Another reason to be optimistic around the inflation outlook is the lack of a severe wage-price spiral. Pay hikes have remained substantially below inflation, by and large, and show signs of moderating. These elements, along with a range of technical and statistical factors, encouraged us to estimate that global consumer price pressures will subside and average 3.6% in 2023.
An easing of inflation expectations should help to take some of the intensity out of the rate-hiking narrative that’s been dominating the headlines, allowing policymakers to orchestrate a softer economic landing than many economists predict.
Is the US in recession?
Whether America suffered a recession in the first half of this year really depends on the definition used and who you ask.
The depth and diffusion of the downturn are the two areas that economists have largely focused on. So far, the scale of the loss in economic output has been relatively small, at -1.6% in the first quarter and -0.6% in the second one. The contraction in Q2 included weakness in inventory build, residential and business investment, and less government spending.
Recession deniers clutch to evidence that US household consumption remains positive and labour markets are robust. Consumer spending rose 1% in Q2, including a noticeable switch from goods into services, a trend that we would expect to continue in the quarters ahead. Unemployment fell to a half century low of 3.5% in July and 22 million jobs have been added since hitting the pandemic low in April 2020.
The consumer continues to be the driving force behind the American economy. Strong labour markets and excess personal savings have helped to cushion demand, but consumer confidence and retail sales are showing signs of real anguish. Meanwhile, higher mortgage rates and elevated prices have led to a dramatic weakening in underlying housing market conditions. We forecast growth in the US economy will slow from 1.6% this year to 0.6% in 2023.
American inflation and policy
July’s inflation reading finally produced the long-awaited moderation. The headline consumer price index (CPI) eased to 8.5% from the 9.1% registered in June. We expect this trend to continue and fall to 6% in December, before averaging 2.9% in 2023.
While the US Federal Reserve (Fed) has kept its immediate policy options open, the central bank indicated that it will likely become appropriate to slow the pace of increases as risks between inflation and economic weakness begin to level out.
We forecast the Federal Open Markets Committee rate-setting body will step down to a 50 basis point (bp) hike in September, after a 75bp move in July, followed by 25bp increments in November and December. The final increase is now projected to be the last in the hiking cycle with the target range at 3.25-3.5%. As we look further out, an easing of inflation expectations and concerns about the impact of tightening financial conditions suggests that rate cuts could be on the cards by Q3 2023.
Europe on the brink
Hopes of a vigorous European recovery at the start of the year have been ruined by the ramifications of the war in Ukraine, supply bottlenecks from China, and record price pressures. Growth forecasts have been slashed, inflation projections ramped up, and recession risk has risen.
Persistent inflation coupled with the sharp tightening of credit conditions and business pessimism all point to weaker economic activity after the summer, followed by a technical recession, or output shrinking for two consecutive quarters, through the winter months.
We maintain a cynical view of eurozone growth, based on energy security risks, weaker domestic demand, slower industrial output, and less investment. While we pencil in anaemic growth of just 0.7% for next year, the risks remain sharply skewed to the downside, with the depth of any European recession likely to be determined by the flow of Russian gas.
ECB to keep hiking despite recession risk
With eurozone inflation not set to peak until September, at 9.5%, the pressure on the European Central Bank (ECB) continues. We expect the Governing Council to use the small window before a recession to prove that they are determined to tame inflation and normalise policy.
We now forecast a more aggressive policy path consisting of increases of 75bp in September, 50bp in October, and 25bp in December. We don’t envisage further hikes in 2023, as activity data turns increasingly negative through the turn of the year.
China set for a subpar year
After growth of just 0.4% in Q1, China’s growth profile weakened again in July, as the world’s second largest economy struggles with the consequences of its pursuit of a zero-COVID strategy and the property market slump. Policymakers have clearly become more concerned about the depth and breadth of the slowdown with retail sales, youth unemployment, and property investment all falling short of economists’ expectations.
Cognisant of the rapidly slowing economy, the People’s Bank of China has reduced the reserve requirement ratio, relaxed its credit policy, and unexpectedly cut its policy rate further in August. We anticipate more easing in these policy areas over the rest of the year. However, concerns around leverage levels, a weaker currency, and encouraging inflation are likely to stop policymakers from providing the stimulus required to materially turn around the Chinese economy in the short term.
Given China’s determination to eradicate COVID-19 infections, the slow recovery in domestic consumption, and the deep fall in property sales, growth this year is expected to be around 3.1%, someway off the official growth target of 5.5%.
UK economy stalls
The UK’s impressive economic recovery ground to halt in the second quarter, with output shrinking for the first time since the pandemic. While GDP dipped 0.1% in Q2, this was a substantial softening from the 0.8% gain in Q1. The weakness was attributed to lower levels of household consumption, a slowdown in manufacturing, and lower spending on COVID-19 testing and vaccinations.
The outlook for the UK economy remains gloomy as surging inflation, higher interest rates, and the rising tax burden are all expected to take their toll on growth prospects. While the Bank of England predicts a full-year contraction in 2023, our growth forecast of 0.9% remains a little more optimistic due to an expected fiscal support package in the winter, easing of long-term energy prices, and a less aggressive policy path.
Bank of England to hit the pause at 2%
Forecasts that UK inflation will peak above 13% in October have encouraged the central bank to raise rates into restrictive territory, with a 50bp increase in August. Given the updated inflation profile, we predict that the Monetary Policy Committee will push ahead with a rate hike of 50bp in September. Furthermore, we now forecast an additional 25bp increase at the November meeting, taking the base rate to 2.5%, after which easing inflation and faltering growth should take some of the wind out of the policymakers’ tightening sails.