- While the fast pace of policy rate increases over the past year and a half is now behind us, service sector activity remains surprisingly robust across a wide swathe of economies.
- Nonetheless, rate hikes have begun to gain traction: demand pressures now appear to be easing and (core) inflation appears to have peaked, although it remains well above central bank targets.
- We forecast a period of subpar growth fueled by higher-for-longer rates ahead, with a relatively slower and softer adjustment back to steady states; this is conditional on strong labor markets.
- The main risk is that demand and inflation pressures remain higher and stickier than expected, prompting even higher policy rates, tighter financing conditions, and an eventual harder landing.
Global economies have mixed macro narratives but a common short list of key issues. Inflation concerns still dominate in the West, fueled by strong services demand and tight labor markets. That being said, policy rates appear to have peaked and are likely to stay elevated into 2024. Weaker-than-expected Chinese growth reflects flailing confidence related to the debt-laden property market and has emerged as both a domestic risk and a global growth drag. The authorities continue to fine tune their response, and this slowdown will have uneven effects across countries.
Global trade growth remains subdued as well which, combined with a strong U.S. dollar will have measurable impacts on a swatch of emerging markets, particularly the more open ones. And geopolitics, supply chains, and energy security and transition issues continue to drive outcomes across the board, including over the medium term.
The services-manufacturing split continues, extending a pattern we have seen over the past year. The latest monthly purchasing managers' index (PMI) data from S&P Global Market Intelligence shows that the service sector globally continues to track in "expansion territory" above 50; however, momentum is easing as the recent tourism boom begins to fade. In contrast, the global manufacturing index remains below 50 as new orders remain soft reflecting destocking and weak trade. The composite PMI, reflecting the net of services and manufacturing sentiment, was weakest in the eurozone, driven by Germany.
Labor markets remain surprisingly strong, although with signs of emerging softness. Unemployment rates in major economies continue to hover near multi-decade lows, below rates consistent with low and stable inflation. However, more contemporaneous labor market measures such as quit rates, vacancies, and payrolls suggest that labor demand is softening at the margin. Moreover, there are indications of labor hoarding, as employers seek to keep workers given recent matching problems in the post-pandemic rebound. A gradual easing of labor demand is key to a soft-landing scenario.
Inflation has peaked, but core measures have been sticky and remain well above central bank targets. The dynamics of inflation in the past two years have followed a common pattern. Non-core prices led by fuels and food accelerated quickly following Russia's invasion of Ukraine. Fueled by a sharp change in demand for services as well as generous government benefits, inflation spread to non-core items. Ongoing strong labor demand has contributed to sticky core inflation and recent data suggests that the decline in inflation to target will be more gradual than the recent climb.
Major central banks have continued to raise policy rates, although the pace has slowed considerably. As we near the end of the tightening cycle, the debate now is between "hawkish holds" and "dovish rises." In their most recent policy meeting, the U.S. Federal Reserve and the Bank of England chose the former while the European Central Bank (ECB) chose the latter. As long as services spending momentum remains strong, and given that financial conditions are not particularly tight, we think that at least for the next quarter the next policy move is more likely to be up than down.
Our Updated Forecasts
The results of our forecasting round repeat the pattern of recent quarters (see table). Owing to unexpectedly strong services demand fueled by tight labor markets, we have raised the current year forecast and pushed out the timing of the (necessary) slowdown. 2023 global growth has moved up to 3.1%, fueled mainly by a higher forecast for the U.S., Japan, the U.K. and Latin America, and offsets a lower number for China. The eurozone forecast is unchanged. We have lowered our 2024 global growth forecast by an equal amount of 0.2 percentage points to 2.8%, led by China, the U.K., and Brazil. The forecast for the outer years of 2025 and 2026 is broadly unchanged.
Our detailed forecasts for the main economies are as follows:
We expect the economy to grow below its potential rate for a drawn-out period. After a stronger-than-expected growth rate so far, the economy is poised to slow down for the rest of 2023 and come in below trend for the next two years. The balance of risk to our baseline forecast is tilted to the downside. Labor-market imbalance diminished during the summer, and high inflation continues to unwind. Still, the last mile of disinflation is going to take longer, with core inflation taking another 12 months to get comfortably near the Fed's 2% target. Policy interest rate appears to be at, or close to, a peak. We anticipate one more rate hike in this tightening cycle, but monetary stance will continue to tighten in real terms, peaking in the second quarter of next year. (See "Economic Outlook U.S. Q4 2023: Slowdown Delayed, Not Averted," published Sept. 25, 2023.)
Our GDP growth forecasts remain unchanged at 0.6% for 2023 and 0.9% for next year. Yet, the geographic composition of growth is slightly different from our previous exercise. We expect Germany to contract more and Spain to expand more than previously. In terms of inflation, we have lowered our forecasts to 5.6% for this year and kept it at 2.7% for 2024. The resilience of the labor market will be decisive for 2024. With inflation set to continue moderating, accelerating wages will lift real disposable income next year, easing income constraints for households, supporting consumption. A pronounced downturn in the labor market could push the eurozone economy into a recession. The trade surplus remains lower than before because of higher energy prices. Key rates may have peaked, but the plateau could be quite lengthy. We do not expect the ECB to start cutting rates before the second half of 2024. Moreover, we believe the central bank might want to accelerate the path of quantitative tightening. (See "Economic Outlook Eurozone Q4 2023: Slower Growth, Faster Tightening," published Sept. 25, 2023.)
Asia-Pacific remains a multi-speed region. We expect China will continue to contain its macroeconomic stimulus following a property-driven downturn. We have cut our 2023 growth forecast for China to 4.8%, from 5.2%, and that for 2024 to 4.4%, from 4.8%. While the rest of the region is slowing on weaker global trade and higher interest rates, we slightly raised our forecast for 2023 growth to 3.9% amid domestic resilience. Growth should rise to 4.3% in 2024 on better external demand and monetary policy easing. Rising food and oil prices bolster the case for central banks to take their time in lowering rates, despite progress in curbing core inflation. See "Economic Outlook Asia-Pacific Q4 2023: Resilient Growth Amid China Slowdown," published Sept. 25, 2023).
We continue to expect most emerging markets (EMs) to grow below trend in the remainder of 2023 and into 2024. Domestic demand remains strong in most EMs, though we expect tight monetary policy will have a more noticeable impact in the coming quarters. Subdued external demand from the U.S., Europe, and China will mean a weak export profile for most EMs in 2024. Structurally high interest rates, without structurally higher growth prospects, will weigh on investment in EMs, constraining productivity growth. On the flip side, high real interest rates mean most EMs have more space than usual to ease monetary policy in the next economic downturn. The growth narrative for EMs remains generally unchanged from our previous quarterly publication. See "Economic Outlook Emerging Markets Q4 2023: The Lagged Effects Of Monetary Policy Will Test Resilience," published Sept. 25, 2023).
Our Top Risk: Stubborn Inflation And Higher Rates For Longer
We see the greatest risk to our forecasts as the continued resilience of services demand and high sticky inflation. This is particularly true for the advanced economies. As noted, real rates are not particularly high and financial conditions are not particularly tight. If demand growth and inflation start to pick up again, central banks would need to commence another leg of rate hikes. This would not only damage their credibility, but it would also further raise borrowing costs and put downward pressure on asset prices. This would raise the likelihood of a harder landing with an undershoot on activity and an overshoot on unemployment before economies reach their steady state.
Such a scenario would complicate matters for EMs. First, higher U.S. rates and a correspondingly stronger U.S. dollar raise borrowing costs and put pressure on capital flows. Second, eventually slower growth can have knock-on effects on the more open emerging markets through the trade channel. Third, the ability to cut policy rates in emerging markets will likely be constrained if the major central banks do not move.
All of the above could be compounded by a China growth slowdown. Trade linkages are the most likely channel here and span the gamut of commodity exporters, supply-chain partners, and exporters of luxury goods to China's middle class. Given the weak confidence loop in China, we are monitoring how the leadership handles the ongoing property woes.
And Now For The Policy Rate Descent
With rates nearing their peak, it is time to start thinking about the path to eventual monetary policy normalization. That is, it is time to start thinking about the descent. We are confident in predicting that the rate mountain is not symmetric. The descent will not look like the fast and furious pace and the way up, and we are not going back to the pre-pandemic world. We see the descent unfolding in phases.
How high for how much longer?
The playbook for central banks appears to be as follows. As inflation falls, real rates will rise and financial conditions will tighten. This nominal freeze, working through the markets, will therefore do the heavy lifting. Market participants largely buy this strategy at least into early 2024. The tension is that central banks are signaling a somewhat longer hold.
Once inflation turns down decisively, how quickly do policy rates come down?
Central bankers are consistently saying they will not commence cutting policy rates in earnest until inflation turns down decisively. We interpret this as inflation momentum (the three-month seasonally adjusted and annualized rate) reaching an inflection point and likely below 3%. There is quite a bit of variation around this path, including in the U.S. Fed dot plots, which show a range of 200 basis points by the end of 2025.
Where do policy rates land, what is the terminal rate?
Once we reach the steady state or sustainable macro path for economies, what is the corresponding policy rate that neither constrains nor stimulates demand. By definition, this rate is the inflation target plus the "natural" (real) rate of interest r*. We suspect that r* has risen from its pre-pandemic level of around 0.5%, owing to two factors. First, the disinflationary impulse of China joining the global production network over the past decades has given way to inflationary pressures owing to near-shoring, friend-shoring, and more secure supply chains generally; this will push up r*. Second, the enormous investment needs of the energy transition will tend to raise r*, which must equilibrate investment with savings.
When is balance sheet normalization achieved?
The descent is not just about policy rates. Central banks are still unwinding their asset purchases made during the global financial crisis, eurozone crisis, and COVID-19 pandemic. These moves, recall, were intended to ease monetary conditions through purchasing longer-term assets and thereby lowering long-term yields. The normalization process has been done passively by the Fed, actively by the BoE, and is just commencing by the ECB. Policy normalization will not be complete until excess reserves and their counterpart excess bond holdings are eliminated.
A New Hope
Two major macro-moving events appear to have peaked and will increasingly be in the rearview mirror. The first is the cyclical or short-lived macro effects of the COVID-pandemic. Supply-chain disruptions have unwound with the clearance of backlogs and the return of a more normal delivery and pricing structure. Second, the services boom fueled by policy stimulus and pent-up demand looks to have peaked as well, much to the relief of central banks. Inflation and rates should fall in the years ahead.
But structural changes are amiss that are still evolving. Geopolitics and energy security concerns continue to move the macro needle. Supply chains are being reconfigured, moving to a risk-adjusted basis from pure cost minimization basis. This is happening with existing players as well as a growing role for newer players like India. Also, energy security continues to drive trade flows which have proven surprisingly responsive, as shown by Europe's reconfigured supply lines for both oil (Africa) and gas (U.S.). Finally, the energy transition involves an enlarged role of the state, and will create new winners and losers, much like globalization. For an orderly future, all of the above must be managed wisely.
- Economic Outlook U.S. Q4 2023: Slowdown Delayed, Not Averted, Sept. 25, 2023
- Economic Outlook Eurozone Q4 2023: Slower Growth, Faster Tightening, Sept. 25, 2023
- Economic Outlook Asia-Pacific Q4 2023: Resilient Growth Amid China Slowdown, Sept. 25, 2023
- Economic Outlook Emerging Markets Q4 2023: The Lagged Effects Of Monetary Policy Will Test Resilience, Sept. 25, 2023
The views expressed here are the independent opinions of S&P Global Ratings' economics group, which is separate from but provides forecasts and other input to S&P Global Ratings' analysts. S&P Global Ratings' analysts use these views in determining and assigning credit ratings in ratings committees, which exercise 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;|
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