Where is the global economy headed in 2023?
By Andrea Siviero, Investment Strategist at Ethenea
The risks of a deeper recession are 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, and central banks will be careful in their tightening path to avoid a sharp contraction of economic activity.
Global economic activity is experiencing a broad-based slowdown with price pressures broadening from headline to core measures of inflation. High inflation, tighter policies and high uncertainty are hurting economic prospects.
Growth forecasts for the global economy have been downgraded several times, while inflation expectations have been rising. The IMF expects global growth of 3.2% for 2022 and 2.7% for 2023, and warns of looming risks of recession. Further downgrades are possible. Inflation will remain elevated for longer at 8.8% in 2022, before dropping back down to 6.5% in 2023.
The global economy is facing very uncertain times and economic projections are extremely complicated. The outlook for 2023 will largely depend on inflation developments, the resilience of economies, and the way in which authorities will manage their macroeconomic policy mix.
Elevated price pressures
Elevated price pressures remain the most serious economic threat for the global economy. Global headline inflation will likely peak, but inflation is becoming entrenched with the price of services, rents, and wages potentially increasing further and remaining elevated for longer than expected.
Several central banks announced a step-down in their tightening path or have already moved to a more moderate pace of tightening in order to first observe the full impact of the measures taken so far. Monetary policy should maintain its course to restore price stability and avoid fuelling expectations of higher inflation in the future. Fiscal policy should provide relief to cushion the effect of higher energy prices, but should not counteract monetary tightening and should aim at progressively reducing the debt burden. However, the risks of policy missteps have increased sharply. Policymakers are confronted with the risks of doing too much or doing too little. 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 greater costs due to bringing inflation under control. Central banks will be careful to avoid a recession, but we expect them to err on the side of overtightening.
Concerns about financial stability may also influence policy decisions. Years of extremely low interest rates have prompted a staunch search for yield in the riskiest parts of the system and the use of leverage to increase returns. Rapid and forceful policy tightening exposes markets to large financial stability risks. A major financial stability accident could force central banks into an early policy pivot, but such an event would be far from positive for the global economy.
As monetary policy acts with a lag, we will see the full effect of the aggressive front-loading of monetary policies during the coming quarters. Global growth will continue to slow down in 2023, dampened by high inflation, tight economic policies and uncertainty. Because of the synchronised global slowdown, high debt level and tight policies, it is difficult to see where the impetus for a vigorous recovery will come from.
Our base case scenario for 2023
We expect core inflation to decline only progressively to levels closer to central banks' medium-term objectives. With inflation elevated and policy rates remaining restrictive, 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 dismal growth hampered by persistent inflation and tighter policies.
However, there are considerable differences across regions. The Eurozone and the UK may already be in a recession, the US may narrowly escape one depending on the future path of the Fed’s monetary policy, while growth in China will largely depend on the reopening process and its ability to manage the property market crisis. Emerging economies in Asia and Latin America seem to have managed inflation risks and may be positioned to support global growth in 2023.
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, and central banks will be careful in their tightening path to avoid a sharp contraction of economic activity.
Risks for the base case scenario
Downside risks to this scenario. A de-anchoring of inflation expectations could force central banks into more aggressive tightening. Tight financial conditions may induce a financial stability crisis or emerging market crisis. Major macroeconomic policy mistakes, or further geopolitical crises, could tip the global economy into a sharper and longer-lasting recession than expected.
Upside risks to this scenario. Tighter financial conditions could work their way through the economy, weigh demand down and subjugate inflation earlier than expected; a rapid resolution of war in Ukraine with a subsequent improvement of the energy crisis in Europe and an easing of geopolitical tensions, combined with China’s decision to progressively ease the strict zero-Covid policy, could cause a faster and more powerful economic recovery in 2023.
