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Economic Research: Global Macro Update: Growth Forecasts Lowered On Longer Russia-Ukraine Conflict And Rising Inflation

The global economy continues to face an unusually large number of negative shocks. At the beginning of 2022, the effects of the COVID-19 pandemic were in retreat in most geographies. As a result, we forecast a robust but uneven rebound, with above-trend growth in most countries and moderately high but transitory inflation. The main questions were when economies would regain their pre-COVID-19 path of output, and what changes brought about by the pandemic would be structural.

Two developments have altered the macro picture. One is Russia's invasion of Ukraine in late February. This sent energy and commodities prices (even) higher for (even) longer and put a dent in confidence, which was at high levels. The second is inflation, which has turned out to be higher, broader based, and more persistent than thought just a few quarters ago. We lowered our growth outlook in a March 8 update and largely reaffirmed this in our second-quarter Credit Conditions reports that came out later that month (see Related Research).

Factors Driving Our Forecast Update

More recently, macro conditions have continued to weaken, and we have again elected to provide an interim macro update between our scheduled Credit Conditions rounds, based on the following five factors.

Data revisions for the first-quarter national accounts will have mainly base effects on our forecast.  Many economies came in lower than expected in the quarter, although a deeper dive is important to determine why. In the U.S., the drivers of the 1.4% decline in GDP (seasonally adjusted and annualized, or SAAR) were a steep drawdown in inventories and a sharp rise in imports. These both suggest strong underlying demand, which was evident in the solid personal consumption outturn. This significant savings cushion in the U.S. also helps explain why households are still willing to absorb higher prices at checkout stands. That key variable rose 2.7% SAAR in the quarter and contributed over 1.8 percentage points to growth. Both of these measures were stronger than the third and fourth quarters of 2021.

Consumer spending is also expected to have been resilient in Europe, despite rising prices, owing to dissaving and pent-up demand. Eurozone GDP increased by 0.8% in the first quarter.

Higher energy and commodity prices will destroy purchasing power for both firms and households.  Moreover, the effects will be immediate, although they could be ameliorated by running down savings. This is particularly relevant in the U.S. and Europe, where households built up savings during the worst of COVID-19 through government transfers and by having limited spending options due to the lockdowns. Higher energy and commodity prices will benefit producers, with the U.S. now the largest energy producer in the world. But these positive effects are typically outweighed by the hit to consumers.

The Russia-Ukraine conflict looks likely to last longer than we expected, which will continue to dent confidence and reroute energy flows.  There is a large degree of uncertainty around how the conflict might develop, but so far it has not spread beyond the two countries, and the direct economic impact outside of higher energy and commodity prices has been limited. Consumer and producer confidence has taken a hit--most notably in Europe--but this is from high levels, and most indicators remain relatively strong. That said, we expect a continued deterioration in confidence as the conflict drags on. Rerouting energy flows is an ongoing structural consequence of the conflict.

S&P Global Ratings acknowledges a high degree of uncertainty about the extent, outcome, and consequences of the military conflict between Russia and Ukraine. Irrespective of the duration of military hostilities, sanctions and related political risks are likely to remain in place for some time. Potential effects could include dislocated commodities markets -- notably for oil and gas--supply chain disruptions, inflationary pressures, weaker growth, and capital market volatility. As the situation evolves, we will update our assumptions and estimates accordingly. See our macroeconomic and credit updates here: Russia-Ukraine Macro, Market, & Credit Risks.

Faster monetary policy normalization will slow demand more than previously expected.  With only a few exceptions, many in Asia-Pacific, central banks are raising--or are expected to raise--rates sooner and faster than we forecast in our previous round. These actions will work through wealth effects as asset prices (financial and nonfinancial) moderate or decline, and through the spending channel as the cost of borrowing rises. However, the transmission operates with lags that are long (several quarters) and variable. We therefore expect a peak impact in 2023.

Slower Chinese growth will have a modest impact on other economies because of the skew toward consumption.  We are revising 2022 GDP growth to 4.2% from 4.9%--most of the reduction reflecting slower consumption growth due to the ongoing effects of the lockdowns. While China is the world's second-largest economy and the biggest contributor to global GDP growth, the degree of spillovers to the rest of the world depends on the composition of the change in growth. Investment links to the rest of the world via supply chains, commodities, and capital goods are stronger than consumption links. This suggests that our slower China growth forecast will have relatively muted effects on trading partners.

Our Revised Baseline And Risk Profile

Our 2022 inflation forecasts have risen almost across the board (see table). Over 2023-2025, our GDP growth numbers remain broadly unchanged from our previous forecast round, but our inflation numbers are higher.

Our numbers and narrative for the main economies and regions are as follows.

U.S.  The outlook is facing more headwinds than what we expected in our March forecast. GDP unexpectedly fell by an annualized 1.4% in the first quarter, which alone shaved 70 basis points off our March forecast of 3.2% for the year. A longer Russia-Ukraine conflict and slower Chinese growth will likely weigh further on supply chains and add upside pressure to already high inflation in the U.S. We now expect headline inflation to reach 6.7% in 2022 and 2.6% in 2023, higher than our previous forecast.

Against the backdrop of higher inflation, we now expect the Federal Reserve to be even more aggressive in interest rate policy, front-loading rate hikes this year so that the federal funds rate reaches its 2.75%-3.00% target by year-end and 3.00%-3.25% in the first quarter. Given that monetary policy affects economic activity with a lag, we expect the full impact of cumulative rate hikes to be felt in 2023. We now expect one more rate hike in early 2023, and then the Fed to hold rates steady until it begins to lower them in mid-2024.

While we do not currently expect a recession in the next 12 months, we recognize that risks have increased. With that in mind, we kept our qualitative assessment of recession risk, out 12 months, in a range of 25%-35%.

Eurozone.  Following a subdued start to the year, it now appears more likely that headwinds will prevail over tailwinds the next two quarters. Therefore, we are revising our 2022 forecast for the eurozone economy to 2.7% from 3.3%. Given the strong statistical carryover from last year and the increase in activity in the first quarter, this new annual forecast suggests slow growth for the rest of the year and does not rule out a contraction in GDP in the second quarter.

While the labor market and the policy mix remain positive factors, higher and more protracted energy and food prices are putting a strain on European consumers. Moreover, a cease-fire in Ukraine may take longer than expected. This will preclude a quick rebound in confidence. The rise in long-term yields, which began somewhat disorderly in Europe, will erode net wealth and may prevent households from tapping into their excess savings as much as expected. That said, the current shock might speed up the green transition of the European economy, and nearshoring might lead European corporates to invest significantly in their domestic markets in the coming years.

The disorderly repricing of bond markets is likely to lead the European Central Bank (ECB) to keep a gradual approach to policy normalization. We expect the ECB to bring the repo rate from zero to a neutral level of around 1.5% in the first half of 2024 by raising the rate in 25 bps increments at a quarterly pace. According to a recent communication from President Christine Lagarde, a liftoff in the deposit rate could occur as soon as July, while the first increase in the repo rate would be expected in September. Unlike the Bank of England or the Fed, the ECB is not considering the outright sales of bonds as an option to reduce the size of its balance sheet.

China.  Following the major economic impact of more stringent-than-expected COVID-19 lockdowns, we have revised down our forecast for China's 2022 GDP growth to 4.2%, from 4.9% previously, and revised growth in 2023 and 2024 up somewhat. In our view, the Chinese government's stance on COVID-19 is unlikely to shift substantially anytime soon. Since this implies a significant risk of renewed lockdowns with major economic impact, we also developed a downside scenario where GDP growth in 2022 falls to 3.5%.

With consumer spending hit harder than investment and industrial production, the impact on other economies should be contained. We estimate that the impact on 2022 GDP growth in Asia-Pacific economies will average 0.2 percentage points, and economies that rely heavily on exporting to China will be affected somewhat more.

Emerging markets.  The weakness in China, spillovers from the war in Ukraine, domestic monetary tightening, and rapidly tightening global financial conditions are all headwinds for emerging market economies. Still, sensitivity to ongoing developments varies across emerging markets, with some more resilient than others.

Emerging markets in Asia are the most at risk from weakening consumption in China. They are also among the most at risk from further supply-chain disruptions, albeit manufacturing continues to operate with limited disruptions under pandemic restrictions. Outside of Asia, Mexico and Turkey stand out (see "Which Emerging Markets Are Most At Risk From Slower-Than-Expected Growth In China?," published April 26, 2022).

If the Chinese government responds to COVID-19-related weakness with more spending on infrastructure, emerging markets that supply metals to China, such as Chile, Brazil, and South Africa, would likely benefit. Commodity exporters in Latin America as well as South Africa have had their exchange rates and domestic stock market indices show more resiliency year to date, though that's declined in the last month.

Emerging EMEA economies, however, have experienced sharp depreciations. Steep price increases in food and energy prices have increased external vulnerability of net importers of both food and energy, while those with sizable food exports and modest energy imports stand to benefit.

Escalating Risks

The risks to our forecasts have picked up since our last forecast round and remain firmly on the downside. The Russia-Ukraine conflict is more likely to drag on and escalate than end earlier and deescalate, in our view, pushing the risks to the downside. As we noted in our previous report, a hard downside scenario would involve a broad-based trade rupture between Russia and the German-centered industrial complex, taking down growth, incomes, employment, and confidence, and spreading to the rest of the global economy.

Our second main worry is inflation remaining higher for longer, requiring central banks to raise rates more than is currently priced in, risking a harder landing, including a larger hit to output and employment. In a particularly bad variation of this risk, fuel and food inflation would remain high even if core inflation (which central banks more directly control) declines, leading to stagflation.

GDP And Inflation Forecasts
(In annual percentage change)
--GDP growth rates-- --CPI Inflation--
Forecast Change Forecast Change
2022 2023 2024 2025 2022 2023 2024 2025 2022 2023 2024 2025 2022 2023 2024 2025
North America
U.S. 2.4 2.0 2.1 2.3 (0.8) (0.1) 0.1 0.0 6.7 2.6 1.8 2.0 1.1 0.8 0.1 0.0
Europe
Eurozone 2.7 2.2 2.1 1.6 (0.6) (0.4) 0.0 (0.1) 6.4 3.0 2.2 2.0 1.5 0.8 0.3 0.1
Germany 1.9 2.5 2.3 1.7 (1.0) (0.3) 0.1 0.0 6.4 3.1 2.2 2.0 1.4 0.7 0.1 0.0
France 2.7 1.8 1.9 1.7 (0.5) (0.2) (0.1) 0.0 5.1 2.5 2.1 2.0 0.8 0.3 0.1 0.0
Italy 2.8 2.0 1.6 0.8 (0.3) (0.1) 0.0 (0.1) 6.0 2.6 1.8 1.7 0.4 0.8 0.3 0.1
Spain 4.7 3.3 2.8 2.2 (1.4) (0.9) 0.1 0.1 7.0 3.3 2.0 1.9 1.2 0.9 0.2 0.0
U.K. 3.3 1.2 2.5 2.2 (0.2) (1.1) 0.3 0.2 7.6 3.6 1.3 1.6 1.3 1.2 (0.3) (0.2)
Asia-Pacific 4.6 5.0 4.8 4.6 (0.5) 0.3 0.2 0.0 3.5 2.9 2.5 2.5 0.1 0.1 0.0 0.0
China 4.2 5.3 5.1 4.8 (0.7) 0.3 0.2 0.0 2.4 2.5 2.2 2.2 (0.4) (0.1) 0.0 0.0
Japan 2.3 1.9 1.1 1.0 (0.1) 0.2 (0.1) (0.1) 1.8 1.4 1.0 1.0 0.0 0.0 0.3 0.3
India* 7.3 6.5 6.7 6.9 (0.5) 0.5 0.2 0.3 6.3 4.8 4.5 4.5 0.9 0.3 0.0 0.0
Emerging economies
Mexico 1.7 2.2 2.1 2.1 (0.3) (0.2) 0.0 0.0 7.4 4.1 3.2 3.0 1.4 0.6 0.1 0.0
Brazil 0.6 1.6 1.9 2.0 0.2 (0.1) 0.1 0.0 10.6 4.9 3.7 3.0 1.7 0.8 0.4 0.0
South Africa 1.8 1.6 1.7 1.8 (0.1) (0.1) 0.2 0.0 5.8 4.4 4.8 5.0 (0.1) (0.3) 0.0 0.2
*Fiscal year, beginning April 1 in the reference calendar year. Sources: S&P Global Ratings Economics and Oxford Economics.

Related Research

The views expressed here are the independent opinions of S&P Global's economics group, which is separate from, but provides forecasts and other input to, S&P Global Ratings' analysts. The economic views herein may be incorporated into S&P Global Ratings' credit ratings; however, credit ratings are determined and assigned by ratings committees, exercising analytical judgment in accordance with S&P Global Ratings' publicly available methodologies.

This report does not constitute a rating action.

Global Chief Economist:Paul F Gruenwald, New York + 1 (212) 437 1710;
paul.gruenwald@spglobal.com

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