Schroders' chief economist Keith Wade gives his views on the outlook for the global economy in 2023, when the battle to tame inflation will remain centre stage.
• Recessions in the advanced economies necessary to tame inflation
• Rate hikes could become cuts in US by end of 2023
• Risks skewed towards stagflation
Businesses, consumers and markets in the advanced economies seem to have adjusted to the idea recession is coming. The chairman of the US Federal Reserve (Fed), meanwhile, has stopped talking about soft economic landings. For their part, UK politicians are no longer telling us they can use borrowed money to ramp up spending and cut taxes while inflation is at four-decade highs. So, encouragingly, policymakers are now helping to create a sense of realism.
History show us that coming to terms with economic realities is important – in the past, false hope has only created a further misallocation of resources. And while all might feel very gloomy right now, an acceptance of the challenges ahead does help create the best possible conditions to take action to ease inflationary pressures. These pressures won’t ease immediately, but by the end of 2023 we might be in a position to start imagining interest rates coming down again.
Falling interest rates would be the payback for taming inflation and the restoration of price stability, which is so important for businesses to plan and invest sensibly. Lower rates would also afford consumers some relief from a cost of living crisis of historic proportions. For investors, it might allow a recovery in valuations, albeit all bets could be off should geo-political fault lines opened up following Russia's invasion of Ukraine deepen, and/or relations between the US and China sour again.
The price of taming inflation
Deteriorating geopolitics might very well take the world in a more 'stagflationary' direction than we envisage. Stagflation describes a situation where growth is low or slowing at the same time as inflation remaining high or rising. And, should labour markets remain in rude health (higher unemployment is, unfortunately, required to restore price stability) we can’t rule out ‘wage price spirals’ further stoking inflation and depressing growth. Both of these scenarios might necessitate even higher interest rates.
But the acceptance of coming recession seems key at this point in time, even if the consequences of recession are yet to be felt. Some 85,000 lay-offs by US technology companies (according to the Crunchbase website) have given us a sense of the pain to come. The price of taming inflation will be quite a slowdown in economic growth and increase in unemployment. Central banks in advanced economies have rapidly increased interest rates in recent months with the objective of cooling demand and quelling price increases.
And a sharp contraction in the US economy will be required to create the slack, or spare capacity, necessary to tame wages, prices and inflation. We expect this will entail unemployment rising above NAIRU (the non-accelerating inflation rate of unemployment, estimated at 4.5% for the US) in Q2 2023, with the unemployment rate hitting 7% at the end of next year – around double the current rate. We’ve arrived at this conclusion by studying previous economic cycles, these being the periods of time in which an economy moves from a state of expansion to one of contraction before expanding again. Our analysis back to the 1960s shows that when US inflation was previously at current levels it always required a fall in GDP of up to 4% in order to restore price stability.
No two cycles are the same, but even with improvements in policymaking and more flexible labour markets, this could still amount to a 2% loss of GDP. So there’s going to have to be a reset in 2023 when we expect US GDP to fall by 1% (see table, below). This projection sets us apart from the crowd with the 'consensus' amongst all forecasters for the economy to grow by 0.2%. It also explains our slightly more modest outlook for global growth at 1.3% in 2023, as we see the US act as a greater offset to strong growth in emerging markets, and China especially.
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