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Macro Outlook 2023

After the post-pandemic “Great Recovery” that characterized 2021, 2022 was again a difficult year for mankind and the global economy. 2022 has been marked by the Russian invasion of Ukraine, the renewed outbreak of Covid-pandemic particularly in China, the explosion of inflation to levels last seen decades ago, and significantly slower global growth. Central banks aggressively tightened their policies to bring down inflation, causing global equity markets to lose about a fifth of their value during 2022. This was the worst performance since the global financial crisis in 2008. Even bond markets endured heavy losses, with indexes tracking government and corporate debt down by approximately 16% in 2022. If we consider total losses accumulated in both the equities and the bond markets, they are estimated to be more than US$ 30 trillion, higher than the losses incurred during the global financial crisis. The global economy entered 2022 with optimistic forecasts for solid growth and expectations that high inflation would progressively fade. Central banks were hoping that high prices would decline as the pandemic related supply constraints were gradually absorbed and that global supply was able to match a turbocharged demand.

However, the global economy was hit by two major shocks. The Russian invasion of Ukraine shook the world and caused immense suffering for the Ukrainian people The war, coupled with the sanctions imposed by the US and Europe, led to a drastic increase in energy and commodity prices, intensifying price pressures that pushed inflation to record levels.

Renewed Covid outbreaks in China combined with the Chinese zero-Covid policy caused a major negative supply shock to the global economy, constraining growth and creating further inflationary pressures. With inflation at multi-decade highs and price pressures broadening, central banks around the globe decided to accelerate the tightening path to constrain aggregate demand, bring down inflation and prevent a de-anchoring of inflationary expectations.

High inflation, tighter central bank policy and high uncertainty hampered economic prospects. Global economic activity experienced a synchronized slowdown with price pressures broadening from headline to core inflation. During the final months of the year, with initial signs that headline inflation may have peaked in many parts of the world, central banks around the globe started to reduce the pace of their tightening. However, inflation has widened and with further increases in wages, rents, and service prices, there is a risk of entrenchment.

"Increased price pressure will remain
the most serious economic threat
for the global economy in 2023."

The global economy is facing very uncertain times, and economic forecasts are currently correspondingly broad. The outlook for 2023 will largely depend on inflation developments, the resilience of economies, and how countries and central banks will shape their fiscal and monetary policies. Increased price pressure will remain the most serious economic threat for the global economy in 2023. Several central banks announced a step-down of their tightening path or have already moved to a more moderate pace of tightening. Since monetary policy acts with a lag, we will only see the full effect of past monetary policy measures in the upcoming quarters. Central banks around the world will be keen to avoid a recession. However, we expect them to continue to focus their monetary policy on containing inflation so as not to fuel expectations of permanently higher inflation.

Facing numerous headwinds, the global economy has been quite resilient in 2022 supported by strong labour markets, accumulated savings, and financial support from sovereigns (especially in Europe). China’s decision to abandon its zero-Covid policy could provide welcomed support to the global economy in 2023, but it will be a bumpy and uncertain road. With inflation elevated, continued tight monetary policy, weakening global trade and geopolitical conflicts, it is difficult to see the momentum for sustained growth in 2023.

The base case scenario for 2023 foresees core inflation to decline only progressively to levels aligned with central banks´ medium-term targets. With inflation elevated and policy rates remaining in restrictive territory, we expect the global economy to enter a shallow recession with a couple of quarters of negative growth (technical recession) followed by a period of weak growth caused by persistent inflation and tighter monetary policy. We see the risks of a deeper recession as moderate, as labour markets remain solid, consumer and business balance sheets are healthy, banks are in a much better shape than after the global financial crisis. Moreover, central banks will be careful to avoid a sharp decline of economic activity.

Nevertheless, there are several downside risks to this scenario. A renewed de-anchoring of inflation expectations could force central banks to tighten more aggressively. Tight financial conditions may induce a financial stability crisis or emerging markets crisis. Major macroeconomic policy mistakes or further geopolitical crises could tip the global economy into a sharper and more prolonged recession than expected.
There are some additional upside risks to this baseline scenario: Tighter financial conditions could have a faster and stronger impact on the economy, weighing demand down and subjugating inflation earlier than expected. A rapid resolution of the war in Ukraine with consecutive improvement of the energy crisis in Europe and an easing of geopolitical tension, as well as China’s decision to abandon its strict zero-Covid policy could cause a faster and more powerful economic rebound in 2023.