Economic and Strategy Viewpoint - Q2 2022

The peak in global inflation is probably not far away, but there are several reasons to think that it will fall relatively slowly. Lockdowns in China have caused bottlenecks in global supply chains to re-emerge, upside risks to commodity prices remain, wage growth is accelerating and demand is re-orientating towards services, where inflation is beginning to pick up.

Worryingly, whereas consumers have so far been able to stomach higher prices, cracks are beginning to appear in demand. Consumer confidence has collapsed as real wages contract, tighter financial conditions are feeding through in weaker housing activity and savings are not as plentiful as they were during the height of the Covid-19 pandemic.

Central banks have set out their stalls to fight inflation and interest rates are set to rise sharply. The mood music amongst policymakers may change once inflation has eased and attention turns back to growth, but it will be difficult to engineer a soft landing and the risks of recession are rising. We have cut our forecast for global GDP growth to just 2.7% for this year and next from 3.8% and 3.0% previously.

In the US, inflation has probably already peaked but we expect the Federal Reserve (Fed) to continue to tighten policy aggressively with its target rate reaching 3% by the end of the year. That is likely to hit activity hard and we have cut our forecast for GDP growth in 2023 to just 1.5%, perhaps clearing the way for rate cuts in the second half of next year.

Similarly, our expectations for the UK and euro area economies have moved in a more stagflationary direction. Inflation is likely to be relatively persistent in the UK, forcing the Bank of England to raise rates further. The European Central Bank is also likely to start raising rates, although will tread more carefully as uncertainty about the spillover from events in Ukraine clouds the outlook.

We have significantly cut our forecast for GDP growth in China this year, where the restrictions put in place to contain Covid-19 are likely to cause GDP to contract in Q2 and grow by just 3.5% in 2022 as a whole. The good news is that we still expect some cyclical improvement to emerge later this year to drive a shallow recovery to 5.5% in 2023.

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