Chilling prospects for the global economy

Key takeaways

• Global economic momentum is weakening with the tightening of monetary policy and the escalating energy crisis in Europe. Strong labour markets provide a cushion.

• The German economy is highly likely to fall into a recession already this year, while the euro area also at risk.

• The US economy will see a near-term recovery, but tight financial conditions will increasingly weigh on the economy, leading to a mild recession in H1 2023.

• Thanks to policy stimulus and waning COVID-19 lockdowns, the Chinese economy will grow about slightly above 5% in 2023. The Japanese economy will likewise benefit from pent-up demand and loose monetary policy.

• Risks to growth are clearly tilted to the downside from higher than anticipated inflation and more abrupt and prolonged policy tightening, especially in Europe.

Slowing global economic momentum

In our last global economic update from June Big Picture: A (mild) recession in western economies seems unavoidable, we warned that the global economy was heading for a mild recession as major central banks would be tightening monetary policy to tackle decade high inflation. Since then, the energy situation in Europe has taken a turn for the worse with Russia cutting off gas supplies, which has led to spiralling electricity and gas prices. At the same time, central banks have doubled down on fighting inflation, hiking policy rates at the fastest pace for decades as inflation has proved to be higher and more persistent than anticipated.

Amid these headwinds, the global economy is showing signs of weakness. Most notably this is seen in the global manufacturing sector, where demand is hit by shift in consumer demand toward services, fading impact of the fiscal stimulus (in the US) and the surge in inflation. While activity in the service sectors has held up better, notably in the US, the activity in the euro area is waning amid a large slump in real purchasing power and falling confidence amid surging energy and electricity prices. While the US economy witnessed negative GDP growth in H1 22, the labour market and private consumption indicators does not suggest that the US has fallen into a recession yet. Labour markets in both the US and Europe remain a bright spot with very low unemployment rates, providing a cushion to the economic headwinds. While the Chinese economy faced significant h eadwinds during the spring, it recovered swiftly over the summer following the lifting of the lockdowns, but the economic momentum has started to weaken again amid headwinds from the property crisis, continuing COVID breakouts and waning external demand.

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