Economic and Strategy Viewpoint – Q1 2023

• The outlook for China has clearly improved since the zero-Covid policy was eased. Activity is normalising and we think a recovery driven by services could drive GDP growth of 6.2% in 2023 and 4.5% next year.
• China’s sheer size means that stronger activity will mechanistically lift global GDP growth, which we have revised up to 1.9% this year, from 1.3% previously.
• However, it is not clear that a services-led recovery in China will offer much support to the rest of the world. Small Asian economies will benefit from the return of holidaymakers. However, prior strong investment and soft external demand means that the recovery is unlikely to spur a renewed investment cycle in manufacturing that sucks in imports from Europe and the rest of the world.
• Commodity exporters may receive some support if prices rise, but the playbook may be different this time. Whereas past recoveries driven by construction have buoyed the prices of industrial metals, a recovery in services may be more supportive of energy which could fire up global inflation again. Some emerging markets would thrive in this environment, but most face a period of sluggish growth as higher interest rates and subdued external demand bite.
• We have become less pessimistic on the outlook for developed markets, but more for domestic reasons. Despite most warning signs flashing red, the US has continued to defy gravity. We still think that higher interest rates, which we now expect to peak at 5.25% in the second quarter, will lead to a recession. But it is likely to be relatively short and shallow. A period of below-trend growth should still bring inflation down over the forecast horizon, allowing the Federal Reserve (Fed) to pivot back to rate cuts in late 2023 to a trough of 3.25% by mid-2024.
• The eurozone is set to avoid recession after some respite from the energy crisis. Inflation should fall back more quickly, relieving some of the pressure on real incomes. The economy is likely to be largely stagnant meaning that while the ECB may raises rates a bit further in the near term, it is also likely to cut next year.
• By contrast, the UK still faces a recession as higher inflation and interest rates, along with austere fiscal policy, dampen the outlook. We think GDP will contract by 0.8% this year. Interest rates may have already peaked with cuts likely in 2024.

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