Fears of 2023 recession rise after most-synchronised rate hike cycle in 50 years

22 Sep 2022

This week highlighted again that where the US Federal Reserve leads, the others will follow — and the Fed chair made it clear that it’s likely to be a journey into a painful economic reality: possibly a global recession. South Africa kept in step, with the Reserve Bank governor highlighting that inflation risks are to the upside.

‘Prepare yourself for the worst.” That was the main takeaway from the US Federal Reserve’s rate-setting meeting this week when it hiked interest rates by 75 basis points (bps) and warned of more pain to come.

Fed chair Jerome Powell best summed up the painful reality of what to expect: “We have got to get inflation behind us. I wish there were a painless way to do that. There isn’t.”

Hot on the Fed’s heels, the UK raised its official rate by 50 bps, smaller than the US rate increase, probably because its energy package will provide inflationary relief in the next few months. The Swiss central bank raised its rate by 75 bps, exiting negative territory for the first time since 2015.

South Africa matched the Fed’s increase with a 75 bps hike in the repo rate, even though the latest consumer inflation data showed early signs of easing. SA Reserve Bank governor Lesetja Kganyago said risks to the inflation outlook are to the upside, with headline inflation only expected to come back into the Bank’s target range of 3% to 6% by the second quarter of 2023.

The Committee expects headline consumer inflation to return to the 4.5% mid-point by the fourth quarter of 2024. According to the Bank, risks to this inflation trajectory include the adverse impact of the Russia-Ukraine war, oil prices possibly rising again in stressed energy markets, and higher electricity and administered prices in the medium term.

The Sarb joined many others in reducing its forecast for global growth this year to 3% from 3.3% at the previous meeting, and 2% from 2.5% in 2023. South Africa’s expected growth rate was also trimmed to 1.9% from 2% this year and 1.4% in 2023. Even these projections may prove optimistic given the Fed’s no-holds-barred restrictive monetary policy stance.

Recent World Bank research analysed the conditions necessary to push the world economy into a global recession and questioned whether one was imminent. As a result of its research, it spells out three possible scenarios, two of which are more likely and not consensus views when the report was published.

The first out-of-consensus scenario is a sharp downturn triggered by additional synchronous policy tightening, with “additional” referring to rate increases not factored into the consensus baseline view.

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The second, most pessimistic scenario, is a global recession that results in “large permanent output losses” relative to the global economy’s pre-pandemic trend. According to the report: “This would have severe consequences for the long-term growth prospects of emerging market and developing economies that were already hit hard by the pandemic-induced global recession of 2020.”

The baseline scenario reflects consensus expectations for growth, inflation and interest rates. However, the report considers the extent of monetary policy tightening factored in as possibly insufficient to meet central bank targets within two years, which raises the risk that inflation expectations may rise and “complicate the return of inflation to its target”.

The odds of this latter scenario playing out have more than likely been substantially reduced if you consider the messaging in the Fed’s latest monetary policy statement. That leaves us with a world that is more than likely going to either flirt with recession or sink into a global recession that results in long-term scarring, with emerging markets in the frontline.

Latest Global Business Sentiment Index data confirms that businesses’ views of global economic prospects have deteriorated further. But expectations of a severe downturn are limited, according to Oxford Economics head of Macro Scenarios, Jamie Thompson.

The index fell 0.4 percentage points in August, to a point where mean expectations for world GDP a year out are at their lowest level since January 2021 — 3.4% below pre-pandemic forecasts. While businesses only see a 1-in-20 chance of a global financial crisis-scale contraction, Thompson says they see a global recession “now almost as likely as not”. The latest Fed messaging and guidance, which could see US rates exceed 4.5% next year, could, however, tip the balance into recession being more likely.

This was an action-packed week in the world of central banks, and it’s worth stepping back and reflecting on the fact that, as the World Bank points out, we are experiencing “one of the most internationally synchronous episodes of monetary and fiscal policy tightening of the past five decades”.

This is in contrast to how policymakers dealt with the 1975 global recession, but looks most like the measures put ahead of the 1982 recession — the period in history most like what we are experiencing now.

The Reserve Bank sees these two periods as highlighting that making timely policy adjustments is critical in reducing inflation and the economic costs of those interventions. Looking back to last year, when the Fed held firm on its view that inflationary pressures were temporary, timeliness may not have been achieved, which means current rate hikes could impose a greater cost on the global economy.

The risks are to the upside, the most significant of which is Russia’s endgame after it escalated its military offensive this week, and the fact that monetary and fiscal policy initiatives are coming off a period of unprecedented easing during the pandemic.

Thus we remain firmly mired in uncharted territory, and likely economic outcomes have arguably never been as uncertain.

But whether we become clearer on whether a global recession is imminent, it will, for a large proportion of the global population, sure feel like the world has already been in one. BM/DM

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