PERSPECTIVE3-5 min to read

Three challenges on the path to a soft landing

Economic and Strategy Viewpoint - Q3 2023


Keith Wade
Chief Economist & Strategist

The narrative has shifted over the past three months as talk of recession has been replaced by that of a soft landing for the world economy. Inflation has started to decline while economic growth is proving to be resilient. For now, we are no longer forecasting a recession in the US.

In marked contrast to 2022, expectations for global economic growth are rising while those for inflation have stabilised after rising sharply over the year. In response, risk assets have performed well with global equity markets rising. Government bond yields have also risen as markets have factored in a higher profile for real interest rates.

Despite the air of optimism, the world economy faces a number of challenges. Here we look at these three challenges in turn.

1. The improvement in growth expectations has not been universal globally

First, the improvement is not universal globally. Although global growth expectations have strengthened, the improvement has been confined to the US and Japan.

Manufacturing-heavy economies were always going to suffer as people switched back to services in the post-pandemic economy. Concerns have been fuelled by a sharp drop in the manufacturing Purchasing Managers Indices (PMIs) with German and French industry slowing sharply and dragging down the eurozone, while the UK has also been weak.

Meanwhile, mainland China also faces challenges in its property market. Given that real estate accounts for around one-quarter of the market’s GDP, structurally weaker activity in the housing market is likely to have caused a decline in long-term trend growth to 3-4% rather than the 4-4.5% that previously appeared possible.

2. Inflation is not beaten yet

Second, the outlook for global economic growth in 2024 largely depends on the behaviour of inflation.

Headline inflation has fallen sharply in the major economies, but this has largely been driven by the fall in food and energy prices. Strip these out and the decline in core inflation rates has been less impressive. The flipside is that service sector prices have accelerated and have kept core inflation elevated.

Unlike the first phase of disinflation, the next phase will come at a greater cost in terms of jobs. US economic growth is forecast at 1.1% in 2024 and we expect the unemployment rate to rise to 4.8% as firms look to maintain productivity growth. This would be consistent with the view that the trade-off between growth and inflation (i.e. the Philips curve) is non-linear.

3. Lags between policy action and the economy appear to be longer

Lastly, there are still issues around how effective monetary policy is in the post-pandemic world.

The monetary policy cycle has been challenging for central banks as many relationships between interest rate changes and economic activity appear to have broken down.

The low starting point for interest rates, looser financial conditions, loose fiscal policy and pandemic effects have combined to make this cycle different. The Fed and other central banks have had to overcome these factors to get monetary policy to a point where it can be restrictive for the economy and inflation. Consequently, the lags between policy action and the economy appear to be longer today.

This does not mean, however, that monetary policy will not work. Central banks will need to pay more attention to the rolling off of fixed rate deals in the mortgage market and maturing of debt in the corporate sector in judging the impact of their actions.

Baseline summary

We have reviewed our economic forecasts in the light of recent data and have made small upgrades for our views on global growth and inflation.

Global growth forecast

We are revising up our growth forecasts for the US in 2023 to 2.3% (previously 1.5%), but slashing the projection for mainland China to 4.8% (from 6.5%). These moves largely cancel each other out to leave our global GDP forecast little changed at 2.5%. We expect global economic growth to decelerate further in 2024 to 2.1% as policy continues to bite on activity.

Global inflation is expected to moderate from 7.2% in 2022 to 4.4% in 2023 and 3.1% next. Within these forecasts there is a marked divergence between the advanced economies and emerging markets with inflation cooling in the former and rising in the latter as mainland China lifts itself out of deflation.

Policy rates are close to their peak and will likely fall in 2024, although we have pushed out the easing cycle to reflect the challenge of beating inflation.

The landing for the world economy is not as hard as before, but 2024 is still forecast to be the weakest for more than a decade (excluding the pandemic year 2020).

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Keith Wade
Chief Economist & Strategist


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