Global growth under pressure despite easing inflation worries
KUWAIT: The global economy continues to hold up better than expected, with resilient consumer spending and still-tight labor markets helping growth in developed markets, especially the US, and severe recession fears waning.
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Inflation has receded from its highs, supporting consumer and business confidence, and bolstering expectations that aggressive policy tightening by major central banks is at or near its end. However, the recent climb in oil and global food prices, together with still well above-target underlying inflation rates in the US and Europe, are likely to rule out early rate cuts in 2024, which could add to growth headwinds there next year.
Meanwhile, weak economic growth figures in China may have helped trigger firmer government policy support recently. If successful in boosting growth, this will have positive knock-on effects on European and Japanese exports though also risks pushing global inflation up. The US economy has outperformed expectations, with GDP growth surprising positively and dissipating chances of recession this year. GDP growth accelerated slightly to 2.1 percent q/q (annualized) in Q2 2023 from 2 percent in Q1 on higher business investment and relatively robust household spending.
The positive momentum has continued into Q3, with strong increases in industrial production and retail sales in July-August. Sales of new homes have also recovered, helped by a tight supply of existing single-family units. The ISM services activity index in August climbed to a solid 54.5, and even its manufacturing equivalent at 47.6 signaled a slower pace of contraction. The consensus is for another strong GDP print of 2.8 percent in Q3, though growth in Q4 could be hit by the resumption of student debt repayments in October.
The tight job market remains at the core of the US economy’s resilience. Although monthly job gains have eased from their unsustainable rates of last year, the unemployment rate at 3.8 percent is at near historic lows and real wage growth is now in positive territory. Unless we see widespread cracks in the labor market, consumer spending and the economic outlook should continue to hold up, offsetting the impact of higher interest rates. Consumer price inflation remains on a broadly slowing path, with core CPI inflation still above target at 4.3 percent y/y in August but well off its 6.5 percent peak last year and further softening seen ahead as the lagged impact of earlier falls in shelter costs feeds through.
With the Fed funds target interest rate now at 5.25-5.50 percent, real policy rates are in positive territory and the Fed is seen delivering perhaps one final 25bps rate hike in November. However, with the economy growing at or above its trend rate, wage growth still high, commodity prices rising again and some narrower measures of inflation remaining sticky, the Fed will be unable to declare victory over inflation very quickly and interest rate cuts are likely to be delayed until the second half of next year.
Europe’s economy loses steam
Europe’s economy is witnessing growing signs of weakness on a steep rise in policy rates and a fragile recovery in China. The eurozone’s services sector, which was outperforming manufacturing for a long period, has now also come under pressure with both sectors’ PMIs coming below the ‘no change’ 50 mark in August. In Q2 2023, eurozone GDP grew just 0.1 percent q/q, following a similar rise in Q1. Moreover, a softening global outlook amid ongoing weakness in Chinese demand are likely to weigh on the region’s exports.
In September, the European Commission cut its growth outlook for the eurozone for 2023 (to 0.8 percent from 1.1 percent in the Spring) and 2024 (to 1.3 percent from 1.6 percent), as Germany slips into recession on a slump in manufacturing and exports. Meanwhile, having also escaped recession so far by a narrow margin, the UK economy faces a similarly soft outlook:GDP contracted 0.5 percent m/m in July versus +0.5 percent in June and could rise just 0.1 percent q/q in Q3 (+0.2 percent in Q2).
Japan’s Q2 GDP growth
Japan’s economy continues its struggle for a robust post-pandemic recovery amid a weaker yen and a softening global outlook. GDP growth in Q2 2023 was revised sharply lower in the final reading, albeit still high at an annualized 4.8 percent. This was a solid upgrade from Q1, but growth was solely driven by a strong performance in the external sector (helped by a recovery in inbound tourism) while domestic consumption and business investment were weak. Moreover, real wages continued to fall for the 16th consecutive month in July (-2.6 percent y/y), boding ill for underlying domestic demand.
In light of the mixed data, the Bank of Japan (BOJ) has reaffirmed its stance on maintaining an ultra-loose monetary policy. However, BoJ Governor Kazuo Ueda has hinted at shifting away from negative interest rates if the data by the year-end suggest that current high inflation (3.1 percent y/y in July) looks like being sustained. The BoJ had earlier tweaked its yield curve-control policy to allow up to 1 percent yields on 10-year government bonds from 0.5 percent earlier, but hasn’t let yields to rise anywhere near this.
As Japan is a net creditor to international markets, any repatriation of overseas funds due to higher rates could have a large impact on the global financial system. Ueda’s signal on ending negative interest rates seems a step in preparing markets for a policy reversal sometime in 2024 rather than earlier. The signals may also have been aimed at stemming weakness in the yen, which is hovering close to 30-plus-year lows versus the US dollar.
China to ramp up support
Following an initial post-COVID rebound, economic momentum in China has slowed amid ongoing problems in the real estate sector, softer manufacturing activity, and declining exports. GDP growth slowed to just 0.8 percent q/q in Q2 2023 from 2.2 percent in Q1, though a base effect pushed growth up to 6.3 percent in year-on-year terms.
Pressures on the real estate sector include falling home valuations that have hit homebuyer confidence, declining property investment, and rising liquidity and solvency risks for developers. Falling land prices have reduced local government revenues and raised concerns about the ability of their financing vehicles to service debt, estimated by the IMF to stand at $9 trillion (55 percent of GDP). The real estate slump has also heightened risks in the country’s $2.9 trillion shadow banking sector.
India’s Q1 growth surges
India’s GDP growth beat forecasts in Q1 FY23/24 (fiscal ending March) at 7.8 percent y/y versus 6.1 percent in Q4 FY22/23. A sharp recovery in private consumption growth and elevated investment spending provided impetus. The government has reiterated its forecast of around 6.5 percent growth for the current fiscal year and leading indicators, including recent PMI surveys, have been robust. However, signs of fatigue are also emerging, with indirect tax collections exhibiting slowing growth in recent months.
Moreover, monsoon rains have been erratic, impacting agricultural production and prompting authorities to control exports of main agri-commodities, including wheat, rice, and sugar. The effects have been felt both locally and overseas, with global food prices spiking. For example, following the ban, Asian white rice prices jumped by around 20 percent in early August. With a general election scheduled for next year, the government may announce other populist measures to support the rural sector, perhaps pushing government spending higher, despite its goal of narrowing the fiscal deficit to 5.9 percent of GDP this fiscal year from 6.4 percent last year.
