Based on the IMF’s figures, the world economy’s recent growth record is: 2.9% (2019), -3.1% (2020) and 6.1% (2021). The IMF’s latest forecasts in April were 3.6% for both 2022 and 2023 but may prove too high.
In 2008 the world economy suffered a Global Financial Crisis (GFC) and in 2020 it was hit by the pandemic and a Global Health Crisis (GHC) Now it is being hit by a Global Inflation Crisis (GIC). This GIC is already becoming a policy crisis for some countries, like the UK. Whether it becomes a Global Policy Crisis (GPC) remains to be seen. There are a number of messages to consider:
First, even ahead of recent developments the world economy looked likely to slow this year
Let’s put current developments in context. At the start of this year, the world economy looked likely to be strong early in the year, as economies in the west benefited from the combination of the continued rebound from the pandemic and the reflationary policies that had been unveiled in 2020 and 2021. China, too, was expected to ease policy this year, ahead of the major political forum in October, at which President Xi is expected to be re-elected.
But even allowing for all this, at the start of the year, it was still expected that the world economy would slow through the remainder of this and into next, as the rebound and reflationary policies wore off, and as monetary policy, outside of China and Japan, would need to be tightened, led by the US. The worry was that we might return to secular stagnation in the west, with economies returning to the relatively weak growth they had seen pre-pandemic. This was a far bigger problem facing western Europe, but still a concern in the US.
Then two shocks hit. One was the war in Ukraine. This is seen by much of the world as a European war and this is reflected in the political approach to it at the UN. Nonetheless, it has global consequences, as it forces energy prices higher. High energy prices have, historically, contributed to slower growth as they hit discretionary spending.
Another shock was the lockdowns in China, because of their zero covid policy. China’s economy is being hit incredibly hard, with internal trade and movement impacted, and policy is being eased. Its 5.5% official growth target looks far from achievable. The shutdowns are also triggering further global supply-chain disruptions, through ports such as Shanghai, exacerbating global inflation pressures.
Furthermore, both shocks exacerbated the biggest challenge facing many economies: inflation.
Second, it is a Global Inflation Crisis but the monetary policy response varies
Because inflation is a global challenge – and because it has been influenced by supply-side shocks such as higher energy prices which have now triggered higher global food prices – this should not divert attention from what is, for financial markets, the biggest issue, the legacy of excessively loose monetary policies. Since the 2008 global financial crisis, monetary policy has been too loose, for too long, in too many countries. The biggest challenge for markets is the impact of monetary tightening now.
There has been a rise in inflation across western economies. That this is more than a UK issue should not divert attention from where the problem lies. Imagine you are driving a car and approach a red light and decide to not only ignore the signal to stop but put your foot down on the accelerator. You are driving dangerously – that some other cars may do the same does not change that fact.
It is not safety in numbers but more likely to cause greater carnage. Last year, in monetary policy terms, central banks, including the Bank of England, not only went through the red light but had their foot down on the accelerator. That was seen through policy rates being kept low and further quantitative easing.
Comparisons are made with the 1970s. That decade began with the UK seen as the low inflation country of Europe but ended with annual inflation averaging 12.5% during that period. Inflation was felt by everyone but particularly the poor and those on fixed incomes, like pensioners. Another lesson is the measures necessary to control inflation are deeply uncomfortable, often requiring sharply higher rates, with damaging economic consequences. Which brings us to now. Interest rates in many countries are far lower than inflation.
While rising inflation is a global problem the monetary response is already varying across countries, naturally heavily influenced by domestic factors.
Take the world’s five largest economies: the US is tightening and the US Federal Reserve (the Fed) believes the economy can cope; China is easing; Japan is keeping policy unchanged, and policy is loosening via a weaker yen; Germany would probably like to tighten, but tensions within the euro are delaying the European Central Bank from tightening.
In the UK, the world’s fifth largest economy, the Bank of England is hiking despite its forecasts pointing to a sharp slowdown and likely recession. Elsewhere, rates are rising in many countries. For example, over the last week India hiked from 4% to 4.4%, while Brazil hiked for the tenth successive month and is one of the few countries whose policy rate of 12.75% is higher than inflation of 11.3%. Such positive real interest rates (where rates are higher than inflation) are often necessary to curb rampant inflation and highlight to some extent how low policy rates are elsewhere.
This week saw US rates rise by 0.5%. Surprisingly, this was viewed by some as a dovish tightening – because the Fed had effectively ruled out “jumbo rate hikes” of 0.75% – but it was anything but. Further significant tightening is expected – combining hikes of 0.5% at forthcoming meetings in June, July and September, plus quantitative tightening through asset sales.
The dollar, in turn, remains firm, not just because such tightening is expected but on the belief that a soft-landing will follow, and while Fed Chairman Powell alluded to the resilience of consumption and investment, the economy is already weakening as seen from the fall in first quarter GDP.
The latest US jobs data, for instance, were robust, generating more than 400,000 jobs for the twelfth month running. 428,000 jobs were created in April, with a particularly healthy 55,000 new jobs in manufacturing. While many see the jobs as a lagging indicator, in the US and UK they may seem as more coincident, not lagging, and thus the market will be reassured by such data as justifying the Fed’s stance.
Higher US rates, a firmer dollar, and a slowing world economy already presents challenges for a number of emerging economies. This could be exacerbated further if the economic situation in China deteriorates more than expected, and the Chinese currency weakens.
Third, the UK policy mix points to problems for sterling
This week the Bank of England’s Monetary Policy Committee (MPC) hiked for the fourth successive meeting, with rates rising from 0.75% to 1.0%. The latest annual consumer price inflation in March was 7%, ten times higher than its rate of 0.7% a year ago. The MPC voted 6-3 to hike by 0.25% with three members voting to hike 0.5%.
The policy response in the UK does not augur well for the economy, with the Bank of England tightening, even though fiscal policy is already tight and the economy is heading for recession.
There was a strong case for the MPC to have left interest rates unchanged at this latest meeting, given the economic headwinds hitting the economy – and that is despite UK policy rates being too low compared to where they probably need to settle.
The direction of rates is up. It is the speed and scale of tightening that is the issue, given how fragile the economy clearly is. With borrowing high, the economy is not only vulnerable to higher rates, but could be impacted sooner as policy tightens. While the UK jobs market is also healthy, like that in the US, the latest indicators, including consumer confidence, suggest it may have made more sense to wait and assess how the economy handles recent shocks, rather than being on autopilot and hiking at every meeting.
Two wrongs do not make a right: it was wrong (and it was clearly wrong at the time) to have been easing last year. It is wrong to be hiking if the economy is falling into recession, as it appears to be now.
The Bank’s economic projections are based on the market’s current view that bank rate rises to around 2.5% by mid-2023, before easing back to 2%. Their projections point to annual growth of 3.2% (Q2 this year), 0.0% (Q2 next year) and 0.2% (Q2, 2024). These are dismal. Likewise, their inflation expectations of 9.7% (Q2 this year), 6.6% (Q2, 2023) and 2.1% (Q2, 2024).
We have been bearish about the inflation outlook for some time. Inflation has yet to peak and will remain elevated throughout this year. It should decelerate next year, as we have previously indicated, but it is likely in our view to settle above the 2% inflation target, probably around 3-4%.
The policy mix the UK needs is a tighter monetary and looser fiscal policy, but currently it doesn’t have that so sterling looks vulnerable, given the growth outlook.
Please note, the value of your investments can go down as well as up.
