Global economy hits reverse

Key points

• Weakening economic indicators and record high inflation encouraged Barclays Investment Bank to slash its growth estimates for this year in many major regions, with the global economy now forecast to expand by just 2.8% in 2022
• While some economists believe the US is in recession, positive US household consumption and a buoyant labour market don’t point to one quite yet
• Weaker employment data and deflating price pressures may see the hiking cycle end in December, with US rates in the 3.25-3.5% range. Indeed, rate cuts could be on the way by the third quarter of 2023
• Soaring energy prices and the war in Ukraine have hit Europe’s economy badly. With the bloc staring a recession in the face, the outlook for growth is largely dependent on the level of Russian gas supplies
• UK inflation is forecast to peak above 13% in October, encouraging the central bank to pursue rate rises

The global economy has taken a turn for the worst. Indeed, after an expected contraction in the second quarter (Q2), Barclays Investment Bank slashed their growth forecast to just 2.8% in 2022.

A worrying mixture of surging inflation, more aggressive rate hikes, and tightening financial conditions has contributed to a slump in business and consumer confidence. Contrary to such dour indicators, US labour markets remain robust, consumer and corporate balance sheets still look healthy, and the service sector has plenty room to recover.

With the news not all bad, if the global economy dives into recession, it is likely to be a relatively shallow and short-lived one.

Peak inflation to strike soon

Global consumer prices look like averaging 6.6% this year, compared to 3.2% last year. That said, the peak in inflation seems to be near, as tighter monetary policy takes the steam out of demand, commodity prices stabilise, and supply constraints ease.

The lack of a severe wage-price spiral is another encouraging sign, with pay hikes being substantially below inflation, by and large. Taken together, this suggests that global consumer price pressures may weaken, cutting average inflation to 3.6% next year.

Has the US economy entered a recession?

Arguably, America has dipped into recession, though a heated debate over whether one can be declared rages. Output shrank by 1.6% in the first quarter and just 0.6% in the second one. Hardly worth getting excited about. However, positive US household consumption and a buoyant labour market don’t point to a recession, with the latter hitting a half century low of 3.5% in July.

By contrast, housing market conditions are on the slide, as higher mortgage rates and a ‘hot’ housing market bite. Overall, the US economy is likely to slow from 1.6% this year to 0.6% in 2023.

Where next for interest rates?

The US Federal Reserve (Fed) has hinted that this year’s pace of rate hikes will slow as risks between inflation and economic weakness begin to level out. Given the state of the economy, US rates may be upped by 50 basis point (bp) at September’s rate-setting meeting, followed by 25bp moves in November and December.

If the labour market data cools and price pressures abate, then December’s anticipated rate rise may be the last in this hiking cycle, with US rates in the 3.25-3.5% range. Indeed, rate cuts could be on the way by the third quarter of 2023 if inflation expectations keep easing and tight financial conditions are a concern.

Europe in a bear hug

The European economy is staring a recession in the face. Tighter credit conditions and a plunge in business pessimism suggests weaker growth in the coming months, followed by two consecutive quarters of contraction (or a technical recession) in winter.

Barclays Investment Bank pencils in eurozone growth of just 0.7% for 2023, and this may be optimistic with the depth of any economic slowdown probably down to the flow of Russian gas.

Turning to monetary policy, with inflation elevated and the economy struggling, the pressure is on the European Central Bank. Policymakers are likely to lift rates by a combined 75bp at the September and October rate-setting meetings, leaving the deposit rate at 0.75% as growth and inflation starts to trend lower.

China pays the price for its zero-COVID policy

The world’s second largest economy has shown little signs of growth this year as the government pursues a zero-COVID strategy and the property market slumps. Reflecting the economic malaise, the People’s Bank of China trimmed the banks’ reserve requirement ratio, relaxed its credit policy, and cut its policy rate in August.

Given China’s determination to eradicate COVID-19 infections via reactive lockdowns, the slow recovery in domestic consumption, and the deep fall in property sales, growth this year will probably miss the official 5% target by some margin.

UK economy hits the brakes

As consumers spent less and manufacturing slowed, UK output shrank in the second quarter for the first time since the pandemic. The outlook does not look good. Surging inflation and higher interest rates are hitting growth prospects. We expect the economy to expand by 0.9% next year, more optimistic than some economists, aided by a likely fiscal support package in the winter, easing of long-term energy prices, and a less aggressive policy path.

UK inflation is forecast to peak above 13% in October, encouraging the central bank to sustain the momentum on rate rises. The Monetary Policy Committee looks likely to lift rates by 50bp in September, before taking the base rate to 2.5% by year-end. Next year, cooling inflation and faltering growth should lighten policymakers’ tightening mood.

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