Towards a shallow recession in 2023 ?
By Andrea Siviero, Investment Strategist at Ethenea
Global growth will continue to slow down in 2023 with the possibility of entering a shallow recession followed by a period of dismal growth hampered by persistent inflation and tighter monetary policies.
The global economy is facing uncertain times and economic projections are extremely complicated. The outlook for 2023 will largely depend on inflation developments, the resilience of economies, and how authorities manage their macroeconomic policy mix.
The global economy has been particularly resilient in 2022 and at the beginning of 2023. The economic outlook is brighter than a few months ago, but persistent inflation, continuous policy tightening, and the lagged effect of last year’s rate increases will produce a further economic slowdown in the coming months.
Ongoing resilient global demand and persistent inflation are challenging central banks’ policies. Central banks need to stay on course and remain restrictive for some time to restore price stability and avoid fueling expectations of future higher inflation.
The risk of policy mistakes has increased. Policymakers need to carefully assess the trade-off between entrenched inflation and the risk of recession. Over-tightening could push the global economy into a harsh recession or trigger a financial crisis while under-tightening would cause entrenched inflation, a de-anchoring of inflation expectations, and increase the future costs of bringing inflation under control.
Therefore, our base case scenario for 2023 is for global growth to continue to slow down with the possibility of entering a shallow recession followed by a period of dismal growth hampered by persistent inflation and tighter policies.
A soft landing is possible but complicated, as ongoing resilient demand requires further tightening by central banks. A sharp recession is unlikely, unless caused by policy mistakes or another exogenous shock.
US : soft landing ?
The US economy remained robust in the second half of 2022 and recent data point to a resilient economy at the beginning of 2023. The lagged effect of monetary and further tightening by the Fed means, however, slower economic activity ahead.
Interest-sensitive sectors (housing) have weakened considerably for several months; industrial production, business investments and the regional manufacturing indicators are on a downtrend and suggest the US economy could soon contract.
The labour market is at full employment, but labour demand is softening in many sectors and wage increases are moderating. Personal income, personal spending and retail sales rebounded after a soft end to 2022, but consumers will at some stage feel the pressure of lower real income.
After its most aggressive tightening cycle of the last 40 years, the Fed has partially achieved its goal of slowing down aggregate demand, but there is more work to do, and the risks of recession have considerably increased.
The Fed has steered the US economy onto a disinflationary path, has gained considerable time and policy space, and seems to be in a better position than other central banks to achieve a soft landing.
The ECB’s restrictive policy could push the Eurozone into an outright recession
The Eurozone economy has been surprisingly resilient in 2022. Despite historically high inflation, the conflict in Ukraine, the energy crisis and China’s economic slowdown, the Eurozone economy managed to avoid a recession. A solid labour market combined with robust fiscal support and the ECB’s cautious approach to policy normalisation were instrumental in avoiding an economic contraction but fuelled sharp price increases across the Eurozone.
The sentiment has improved markedly from the lows of last year. Gas prices dropped considerably, energy supply has been diversified and the fear of a full-blown energy crisis has vanished. Industrial production is weak but stabilising thanks to the easing of supply chains and China’s reopening. The labour market is robust, and surveys of future activity are giving consistent signs of economic expansion.
Despite the improvement in economic sentiment, the medium-term outlook remains challenging. The Eurozone economy is slowing, uncertainty is high, and a shallow recession in 2023 cannot be ruled out. Price pressures are easing at the headline level, but underlying inflation is still too high and broadening. Core inflation remains at an all-time high and domestic demand may drop because of the real income squeeze.
The ECB switched to a more aggressive tone at the end of last year. Having been late in tightening policy, the ECB must stay on course and bring policy into restrictive territory even if it could risk pushing the Eurozone into an outright recession.
China : positive supply and demand shock for the global economy
China’s leadership decided at the end of last year to exit its zero-Covid policy, cristallising this year’s economic priorities aimed at supporting economic recovery with fiscal and monetary policy expansion accompanying the reopening process. The reopening process will be bumpy, but China’s leadership seems determined to achieve its economic goals.
Despite strong policy support, the economy remained soft at the end of last year because of weak domestic consumption, softening international demand and ongoing high unemployment. However, there are signs that case numbers have peaked in large cities and mobility indicators have improved.
Credit is expanding again, and survey indicators turned positive in 2023 with both the manufacturing and the service sector in expansionary territory. The service sector and the construction sector are recovering fast thanks to the reopening process and supported by policy and infrastructure projects. The manufacturing sector is also rebounding thanks to an improvement in domestic and export orders.
China’s reopening represents a positive supply and demand shock for the global economy. A sustained Chinese recovery will boost aggregate demand cushioning the weakening momentum of the global economy. China’s acceleration will increase Chinese demand and will support growth in commodity-producing countries but risks further fuelling headline inflation.
