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Our views 25 July 2022

A new base case: Even less growth

5 min read

After a strong recovery in 2021, global growth appears to have returned to a more ‘normal’ pace in 2022.  

However, challenges have built to the recovery over 2022 and 2022/2023 looks set to see a more serious slowdown in the global economy, as households struggle with the high cost of living, companies postpone investment decisions in light of increased economic uncertainty and high costs, and as the economy responds with a lag to higher interest rates.

Inflation looks set to remain at relatively high levels through to the end of 2022 and into 2023. Inflation is forecast to fall though, as supply chain problems ease and after a fall in commodity prices in June (and assuming a further down-leg to come, notwithstanding significant uncertainty around European natural gas prices).  

Monetary policy tightens significantly into 2023 (for more on the interest rate view, see How high will policy rates go, June 2022), though fiscal policy is likely to be somewhat more supportive in a number of economies as governments attempt to ease the cost-of-living squeeze.

Activity growth expected to slow more than in previous forecasts

GDP growth slows in 2022, partly reflecting normalisation after the strong pace of reopening-driven growth in 2021, but also partly reflecting the impact of high inflation, supply constraints and, increasingly, interest rate increases. Compared to earlier in the year, inflation has surprised my forecasts on the upside and central banks look set to hike much faster than I’d originally assumed. Modestly negative quarters of GDP growth (technical recession) are pencilled into the forecast for several economies including the US (in 2023), the UK (over the turn of the year) and euro area (H2 2022). There is some probability of the US being in technical recession in H1 2022 already (not central case) given GDP contracted in Q1 on a fall in net exports (Q2 GDP is released at the end of July).

Overall annual growth rates are nevertheless assumed positive in 2022 and 2023; Household spending and business investment drive the slowdown, but the scale of slowdown is assumed modest by the standards of recent recessions. That largely reflects the assumption that inflation falls; it also reflects the still high cash levels of both households and corporates in aggregate; and reflects an assumption that fiscal support will help take some of the pressure off household finances.

Brexit is still forecast to remain a modest underlying drag on UK growth with tensions still high between the UK and EU. China is assumed to experience repeat setbacks in GDP growth into 2023, driven by the government maintaining a zero-tolerance approach to continued Covid outbreaks but counteracted somewhat by further policy support for the economy.

Increases in the unemployment rate likely as demand slows

Modest increases in the unemployment rate are assumed in the US, UK and euro area in 2023. This reflects both a forecast slowdown in labour demand and an assumption of somewhat higher labour supply as some of those that left the workforce during the pandemic return to work in response to the jump in the cost-of-living. Arguably we are seeing some signs of the latter in the data already (e.g. a fall in UK inactivity). Wage growth is forecast to be relatively strong in 2022, into 2023, reflecting high inflation and the starting point of a tight labour market.

Inflation still expected to fall

Inflation falls in H2 2022 on the forecasts (with the fall starting later in the UK reflecting a large, expected increase in energy bills in October 2022). Slower demand, lower inflation expectations (in response to monetary policy tightening), some improvements in supply chain problems and somewhat lower commodity prices are all assumed to help. Oil prices fall in the forecasts (in line with market pricing at the time the numbers were compiled). Inflation in later years is a little stronger than it would otherwise be, assuming that central banks are unable to return inflation expectations all the way back to pre-pandemic norms and assuming some frictional costs associated with transitioning to a lower carbon economy.

Policy pulling in different directions

The central case assumes that monetary policymakers tighten policy significantly into 2023, but that there is further (though relatively modest) support for the economy from fiscal policymakers. 

  • Monetary policy: In the base case forecasts, the US Federal Reserve (Fed) hike rates into restrictive territory into 2023, peaking at around 3.75% for the upper end of the Fed Funds target range in H1 2023, but then is assumed to cut rates slightly in late 2023 as inflation settles at lower levels. The European Central Bank are assumed to hike relatively rapidly into 2023 but stop a touch below their assumed neutral rate in response to the slowing in externally driven inflation pressures. Bank of England interest rates are assumed to peak at around 2.25%, marginally above the likely neutral rate. For more, see How high will policy rates go (June 2022).
  • Fiscal policy: Governments are assumed to add modestly more support measures in response to political pressure, reflecting the higher cost-of-living. Additional fiscal support is also assumed in China. Tightening measures to improve government finances are likely in the later years of the forecast in some countries. However, given spending imperatives associated with demographics and climate change, these are assumed to be a modest rather than a strong overall drag on growth.

Risks are sizeable on both sides of the forecast, but still feel somewhat skewed to the downside. In the US, the economy could respond much more strongly to interest rate hikes than I have pencilled in, especially if that were to be accompanied by a significant housing ‘bust’. In Europe the threat to the economy from reduced natural gas supply is a significant one. China’s housing market problems could evolve into something broader and more serious for the financial sector more broadly. There are still things that could go ‘right’ though, not least a much faster fall in inflation than I have pencilled in, for example, if we see a substantial reversal of both supply chain problems and commodity price rises seen earlier in the year, which lead to price cuts.

Table shows economic data and forecasts from 2021 - 2024 for GDP growth, CPI and policy rate across different regions

Source: Bloomberg, Refinitiv Datastream, National statistics offices, IMF; All forecasts (figures for 2022 onwards) are RLAM. Note: US policy rate is upper end of Fed Funds range; ECB policy rate is refi rate. As at 21/07/2022.


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