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Unfinished business
Global Economics Quarterly.
- Banking sector woes make it clear that the most aggressive tightening cycle in decades is taking its toll…
- …yet with the global economy starting the year on a firmer note than feared and inflation still stubbornly high…
- …central banks have more to do – but will have to balance the risks between inflation persistence and financial stability
March 2023 saw a significant bout of financial market volatility as concerns about the US banking sector spread to Europe. It took the shine off what had actually been a better-than-expected start to the year for global activity, largely thanks to China reopening and lower energy prices in Europe.
The most aggressive hiking cycle in decades was taking its toll on parts of the wider economy even before the recent market turmoil. January data showed US and European banks were already tightening their lending standards. Housing markets were also reeling from the impact of higher mortgage rates and delinquencies on US credit cards and auto loans had started to rise.
The most aggressive hiking cycle in decades was taking its toll on parts of the wider economy even before the recent market turmoil.
Yet inflation remains stubbornly persistent. While the headline global inflation rate seems to have peaked back in September or October, February’s readings were surprisingly strong thanks to services and food prices. Labour markets are still tight, with wage growth still accelerating in the eurozone.
This makes it even harder for central banks to strike a balance. They are of course acutely aware of the risk of more intense bouts of financial instability which could make them consider interrupting monetary tightening, or even cut rates. This would represent “Financial Stability Dominance”, where a financial stability operation gets in the way of preventing inflation persistence. Central banks would never explicitly say it, but it could well mean tolerating a slightly higher rate of inflation, and a worse growth-inflation trade-off, in order to preserve financial stability.
Certainly, as of late March, pricing suggested financial markets believed the European Central Bank would stop hiking soon, and that the Federal Reserve could be cutting rates a few times before the end of the year.
We aren’t so sure. The message from the Fed and the ECB at their March meetings, at which they continued to raise rates by 25bp and 50bp respectively, was that they still have more to do in the fight against inflation. Our forecasts suggest they are likely to continue to tighten a little further with no rate cuts from the Fed until 2024. Much will depend on what the data tell them in the next few months – and when it comes to predicting that, well, as Fed Chair Jay Powell himself said: “We simply don’t know”.
Key forecasts
On global growth, we have actually revised up our forecast for 2023 to 2.3% (from 1.8%). This may appear counterintuitive: but the US and Europe both held up better than feared towards the end of last year, which gives a better carryover effect, and the dramatic fall in European gas prices has materially altered the backdrop for early 2023. We no longer expect outright recession in the eurozone or UK. The bigger impact, though, is from China, where we have lifted our annual average 2023 forecast from 5% to 5.6% amid growing evidence that the reopening is on track.
2.3%
Global 2023 GDP forecast, up from 1.8%
Even with these upward revisions, though, 2023 is set to be a weak year. Falling goods exports and high interest rates do not bode well for investment or consumer spending. We also lower our 2024 growth forecasts in both the advanced economies and the emerging world. In the US and eurozone alike, we see a protracted period of sluggish activity.
When it comes to inflation, falling energy prices are set to drive headline rates lower but core pricing pressures are proving to be much stickier, particularly in the developed world. We continue to see annual global inflation of above 6% this year and above 4% in the next. This underlines that, despite growing financial stability risks, taming stubbornly high inflation remains unfinished business.
First published 28 March 2023.
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