The US economy will likely be in a recession though its depth and magnitude will be shallow, buffered by still health labour market conditions and improved wage growth. — Reuters
LAST year was a year of plentiful turbulence and the ride has been very bumpy for governments, businesses, households and central banks.
With the world economy already hurdled by the supply chain disruption-induced inflation, tight labour market conditions, revived consumer demand from excessive fiscal stimulus and ultra-loose monetary policy, Russia’s aggression in Ukraine added sharply to the commodity, energy, food, and industrial material prices.
This is pushing the world economy to the risk of stagflation – high inflation and low economic growth.
The impact of the Covid-19 pandemic is still lingering.
The prolonged conflict in Ukraine is dragging down global growth, putting additional upward pressure on prices, and interest rates, and a much more aggressive monetary stance by the Federal Reserve (Fed) and other central banks around the world.
The global economic growth rate trend is weakening rapidly.
The International Monetary Fund, World Bank, Organisation for Economic Co-operation and Development or OECD and central banks have trimmed economic growth estimates to align with high inflation, higher interest rates and slowing economic activity.
Though the world’s two largest economies (the United States and China) have exceeded growth expectations to grow by 1.8% and 3.9% in the third quarter of 2022, data indicated a continued slowdown.
Navigating the economy in 2023
Risks to the global economy remained two sided.
While there are threats and challenges, there are some tailwinds and silver lining from a still strong job market, and the inflation has come off from the recent peak, thanks to cooling of commodity and energy prices.
Global outlook and potential recession
The global recession risk mounts. Our base case expects the global economy to grow by around 2.5% to 2.7% in 2023, seemingly recessionary feel like as inflation and the lagged impact of higher interest rates headwinds, as well as tighter financial conditions, slow down domestic spending and business activities.
The US economy will likely be in a recession though its depth and magnitude will be shallow, buffered by still health labour market conditions and improved wage growth.
In the eurozone, the contraction of economic activity in the fourth quarter of 2022 is set to continue in the first quarter of 2023.
Amid ongoing policies to ease stress in the property sector, China’s better economic growth expected in the second half of 2023 due to the ending of the zero-Covid-19 strategy will continue to serve as a stabiliser for global economic growth in 2023.
Sustained downward economic pressures leave room for China to further loosen its monetary policy in 2023.
Inflation pressures stay longer, albeit lower
What has started as the supply disruptions and cost-driven inflation pressures have broadened to other goods and services.
The improvement in labour market conditions and higher wage growth have reinforced supply disruptions and costs-driven inflation, compelling the central banks to press the brake even harder.
A look at the data suggests that global inflation peaked in 2022 after hitting the highest level in four decades.
The consumer price index or CPI readings have moderated amid the underlying price pressures still lingering. There are reasons for us to think less cause for concern about inflation in 2023.
With commodity and energy prices cooling off from their peak, the supply disruptions and labour-market pressures subsiding, and combined with the effects of global central banks’ interest rates hikes to cool off demand, global inflation rates likely will cool throughout the year 2023, but the cool-down period will be long and slow.
Interest rates unlikely pivoting back towards cut in 2023
Almost all global central banks have hiked interest rates faster and higher in recent months of 2022, hardening their resolve to bring down inflation as well as anchor inflation expectations.
With inflation likely to remain high for some time despite global energy and food prices softening in recent months and a sharp easing in supply-chain pressures in consumer goods markets, a pivot back towards an interest rate cut is unlikely in 2023.
Rather, the quantum of interest rate hikes will be smaller compared to steep hikes at the beginning of the rate tightening cycle.
In the United States, as inflation most likely will be significantly above the Fed’s long-run target of 2%.
This means that the Fed is expected to keep the Fed funds rate higher at 5% to 5.25% in 2023. The European Central Bank’s main refinancing operations rate is expected to remain at 3% throughout greater part of 2023.
Regional currencies to regain traction
The US dollar index, which has risen by 16.3% at end-October 2022 against a basket of major currencies, firmly supported by the Fed’s unwavering determination to bring inflation down to acceptable level, is back towards its target of 2%.
The aggressive monetary tightening and the resultant widening interest rate differential in the United States’ favour, as well as the reversal of capital flows from emerging markets to the United States, have exerted downward pressures on the currencies of emerging markets.
In November and early December 2022, the US dollar took a breather as the Fed signalled smaller interest rate increases are likely ahead.
Moving to 2023, there are factors to watch that could lead to a reversal of the US dollar ascending trajectory or a pause in the dollar’s rallying momentum.
These include a tapering of the Fed’s hawkish monetary stance or it pauses rate hike at a high level for a while, plus also demand for safe haven assets as the US Treasuries start to wane.
With the US interest rate pausing and the rate differentials somewhat stabilising or narrowing relative to foreign central banks, we expect the US dollar index to enter a period of softening against major as well as certain emerging currencies, probably in the second half of 2023.
However, this is premised on the global economic prospects as a sharp economic slowdown will have a dampening impact on emerging economies via both trade and financial channels.
In conclusion, a deceleration in global growth, which started in 2022 is expected to continue into 2023.
The global growth outlook will continue to face headwinds from tighter financial conditions amid still high inflation in major economies and the domestic challenges in China.
The downside risks include an escalation of military conflict in Ukraine, more intense geopolitical tensions between the United States and China, worsening domestic headwinds in China and potential energy rationing in Europe.
Lee Heng Guie is Socio-Economic Research Centre executive director. The views expressed here are the writer’s own.
