Major steps toward recession
The first half of 2022 was characterised by a sharp slowdown in global economic growth and persistently high inflationary pressures. Not only the war in Ukraine, but also the COVID-19 outbreak in China pushed the global economy into a stagflation-like scenario.
With inflation at multi-decade highs and price pressures broadening, central banks around the world decided in the second quarter of 2022 to accelerate monetary tightening in order to contain aggregate demand, lower inflation and prevent a de-anchoring of inflationary expectations.
In an environment of persistently high inflation, slowing economic growth and aggressive monetary tightening, the risks of a global recession have increased significantly.
We are witnessing a synchronised global economic slowdown, with composite PMIs declining for several consecutive months and major advanced economies already in contractionary territory.
“The situation is heterogeneous across regions”
Dr Andrea Siviero
The baseline scenario for the global economy has been repeatedly downgraded to reflect slower growth and higher inflation. In July, the IMF adjusted the global growth forecast for 2022 from 3.6% to 3.2% and for 2023 from 3.6% to 2.9%. A warning of an impending recession was also issued. This challenging macro scenario is reinforced by several potential threats to the global economy:
- A sudden stop of European gas imports from Russia
- Inflation expectations could become unanchored, requiring even tighter policies
- Tightening financial conditions could induce major crises in emerging economies
- Renewed Covid outbreaks and lockdowns
- A further escalation of the real estate crisis in China
- Geopolitical crises that could hinder global trade and cooperation
While we are globally observing a synchronous economic slowdown and monetary tightening (with a few notable exceptions), the economic outlook and inflation dynamics vary across countries.
Focus: US economy
The US economy weathered the pandemic well thanks to unprecedented policy support. Inflation was driven primarily by strong aggregate demand and showed worrying signs of becoming broader and more structural. The labour market is at full employment, wages are rising at a healthy pace, and personal income and spending remained solid despite weak consumer confidence.
Faced with a decade of high inflation and a thriving economy, the Fed began raising interest rates back in March, increasing the federal funds rate by 3.25% to date. In order to bring inflation down and keep inflation expectations at a good level, the Fed has clearly stated its intention to tighten policy further and keep the policy rate at a high level for an extended period of time.
Fed tightening is gaining traction and aggregate demand is slowing. Restoring price stability will almost inevitably require a sustained period of slow growth and higher unemployment, and a recession is becoming more likely. On the positive side, the Fed appears to be on track to bring inflation back under control, has gained policy space, and can still count on a resilient economy and a solid employment level.
The Eurozone economy has not yet fully recovered from the pandemic shock and is suffering from historically high inflation, energy shortages and a damaging drought.
Europe has been hit hard by the war in Ukraine and the resulting sanctions and trade disruptions, and remains particularly vulnerable to developments within the energy markets. Economic activity is subdued and the industrial sector continues to suffer from supply shortages and weak global demand. The labour market remains healthy; however, wage growth was moderate and consumer confidence is at an all-time low, with consumers suffering from a sharp decline in real disposable income and an erosion of their purchasing power.
Record-high inflation is primarily due to the sharp rise in energy prices and the weakening of the euro, but it is slowly widening and becoming entrenched. The ECB only began tightening monetary policy in July in an environment of slowing economic growth. The ECB's stated determination to forcefully bring inflation back to target levels makes a recession in 2023 appear ever more likely. Fiscal policy will mitigate the damaging effects of stagflation, but after the summer, recession seems almost inevitable.
The National People's Congress announced an ambitious official GDP growth target of 5.5% for 2022, but officials have already tacitly acknowledged that this target will not be achievable. The Chinese economy has been slowing down for some time, hampered by tightening regulations, repeated Covid outbreaks, and strict lockdowns/closures of large economic zones.
The real estate sector is in deep crisis and shows worrying signs of overinvestment and overleverage. Despite strong monetary and fiscal policy support to stimulate growth, domestic consumption is weak and credit growth is low as businesses and households remain pessimistic about the economic outlook.
Accommodative policies will continue to boost growth, but excessive debt, weakening demand, and tensions between economic objectives and health concerns are likely to continue to hamper growth for the rest of the year. Geopolitical tensions with the US over Taiwan are an additional concern for China and the global economy.
Will the global economy achieve a soft landing and avoid a recession?
Economic data is mixed and uncertainty is high. The gap between hard and soft data is widening: surveys point to a slowdown of economy, while hard data remain relatively stable.
Against the background of solid labour markets, consumption is holding up reasonably well, while consumer and business confidence are close to their lowest levels of the cycle. Manufacturing is showing signs of sluggishness, and real estate markets around the world are cooling rapidly, with worrying signs of overinvestment and looming real estate crises.
Inflation developments and the resilience of economies will be crucial to avoid a recession. If inflation remains high, central banks will tighten policy further, the economic outlook will deteriorate and recession risks will increase.
How will the macro scenario evolve in the coming months?
Over the summer, signs of weakening aggregate demand, some easing of supply conditions, and a decline in commodity prices gave markets hope that central banks could recalibrate their policies to achieve the hoped-for soft landing.
However, central banks need clear and convincing evidence of a decline in core inflation to reconsider their tightening path. Indicators such as wages, utilities, insurance prices and rents suggest that inflationary pressures have become entrenched and that stronger structural inflationary pressures exist.
Entrenched inflation requires more time for successful policy. Central banks have made it clear that they are determined to bring inflation down and are in no hurry to shift to an accommodative stance.
Will the stagflation scenario turn into a recession or will central banks be able to steer the respective economies to a soft landing?
Achieving price stability will require an extended period of tight monetary policy and higher yields. Central banks will continue to tighten their policies and raise interest rates further to prevent inflation expectations from de-anchoring, leading to a global slowdown and eventually to a potential recession.
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