Global growth to slow in 2023 as central bank tightening bites

Inflation has undoubtedly been the key economic theme of 2022, with price growth breaching decades-long records in several major economies. Spurred on by global supply-chain disruptions and higher energy prices due to the Ukraine-Russia conflict, annual price growth in the latter part of 2022 hit rates last seen in 1981 in both the US and UK. This runaway price growth in turn saw central banks across the globe stepping up the fight against inflation by hiking key lending rates. The Federal Reserve Bank, Bank of England and the European Central Bank have raised rates this year by a cumulative 4.25%, 3.25% and 2.5%, respectively. As a tumultuous 2022 comes to a close and we begin to look forward to 2023, a major question will be “what next?” for central banks, and what those decisions in turn mean for the outlook for global growth.

Although tentative signs are beginning to emerge that inflation may have reached its peak in most developed markets, it appears unlikely that central banks will be in any hurry to undo any of the tightening seen thus far. In fact, recent statements from the FED, BoE and ECB have all emphasized that that policy makers are themselves expecting to have to raise rates further than previously anticipated, albeit at a slightly slower pace than seen in 2022. Clear evidence of this was visible in the Fed’s latest dot plot - a summary of the path committee members expect interest rates to take over the next few years - which showed broad support for further tightening next year. Fed policy makers now expect interest rates to peak at around 5.25% by the end of 2023, up from 4.75% when the dot plot was last published in September. The market is more optimistic on the inflation outlook, and is pricing in a peak Fed Funds rate of 5.0% in the first half of next year, and then 50bp of cuts in late 2023, taking the Fed Funds rate back to its current level of 4.5%.

Some of the hawkishness from central banks may, at least in part, be an attempt to convince consumers and financial markets alike that they intend to remain tough on price growth, to avoid higher inflation expectations becoming entrenched in wage negotiations. Strong wage growth and a robust labour market have been a particular area of concern for policy makers this year. Central banks will continue to pay close attention to labour markets in 2023, as they have yet to show much response to rising interest rates. Unemployment rates across major economies have remained at historically low levels. US and UK policy makers will be hoping recent rises in vacancy rates and a small upward shift in unemployment rates seen in October will mark the start of a cooling off in labour markets. There are also signs in the UK and US that consumers may be beginning to feel the impact of higher interest rates and inflation, with some measures of retail sales and housing market activity starting to fall. 

The impact of large cumulative interest rate rises across much of the world mean that global growth will slow into 2023. The IMF now expect global growth to fall to 2.7% in 2023 from 3.2% in 2022 and 6% in 2021. The Fund noted that while GDP growth is likely to remain positive next year, high inflation and rising interest rates would make 2023 “feel like a recession”.

While we think the UK and Eurozone economies are probably already in recession, there is a growing expectation that the economic contraction may be less deep than previously feared. This is on the back of a variety of short-term high-frequency indicators performing better than expected. An outright recession is harder to call for the case of the US economy, although it is undoubtedly flirting with one. At present we expect the US economy to grow by less than half a percent in 2023.

Perhaps the largest question mark for inflation and global growth in 2023 is around the impact of Covid-19 on China and its knock-on impact on the rest of the world. As China battles large scale outbreaks of Covid-19 into 2023 the short-term impact is likely to be dampened domestic demand curtailing global growth, and further supply-chain disruptions. As activity normalizes however, China’s economic recovery could help to pull the rest of the world out of recession.