22 Sep 2023
As global inflation shows further signs of easing, the era of aggressive interest rate rises may finally be drawing to a close. Some emerging market central banks have already started cutting rates, while major central banks are hoping they won’t have to lift them higher (Charts 1-2). However, the inflation battle is not over, and monetary policy may need to stay restrictive for a sustained period of steadily lower inflation.
Rather than a focus on how much higher interest rates need to go, it is now more a question of how long they need to stay high. Central banks may well still have to raise rates a little more, but the overriding message from both the European Central Bank (ECB) and the Federal Reserve is that even if rates have peaked, rate cuts could still be a way off, a view we tend to share.
Central banks are emphasising that future rate decisions hinge on the data: they are mindful of policy lags as well as the risks of overtightening. A recession may be required to drive inflation back to target, but current central bank projections are pointing to tolerance for inflation to run above target for 2-3 years as long as it is moving steadily lower. The latest Federal Open Markets Committee (FOMC) projections do not show inflation back at target before 2026.
Some economies are already in or flirting with recession and the slowdown in global growth has become more apparent. US growth has again been the main upside surprise. Mainland China’s recovery has underwhelmed, but there are now signs of stabilisation in industry, services and credit growth, while much of Europe, particularly Germany, has been dragged lower by the ongoing weakness in world trade. Globally, there are also growing signs that higher policy rates are weighing on activity, even if more slowly and more variably than most anticipated.
Inflation, however, is still heading lower globally (Charts 2-3) which is lessening the squeeze on real incomes and leading to some stabilisation in consumer confidence, particularly in Europe. Nonetheless, the renewed supply-driven rise in oil prices and recent spikes in food prices in economies, such as India, provide a stark reminder that we are now in an era of higher inflation volatility, where key commodity price changes are a function of supply as much as, if not more than, changes in demand.
However, wages are still rising quickly in much of the world and it is the labour market that still poses the biggest risk of inflation persistence and will be the key indicator that tips the balance as to whether policy rates need to rise further. The US has seen wage growth moderate more than elsewhere over the past year, but recent progress has been slower. Pay growth has already been accelerating across much of Europe, underlining the reason why central banks cannot afford to relax on the inflation front any time soon.
Thanks to the ongoing resilience of the Americas, Japan, India, and Indonesia we recently raised our global GDP growth forecasts for 2023-24, even though we lowered expectations for mainland China, much of ASEAN, Europe, the Middle East and Africa. We forecast global growth of 2.5% for this year and 2.3% for next, and inflation of 6.5% and 5.9%, respectively.
We think the US will avoid a traditional recession and financial crisis, and will not start to cut rates before Q3 2024, while the ECB will likely wait until even later in the year. In Asia, we see strengthening in ASEAN. Among the other emerging economies, we think that the fastest pace of rate cuts will still be in Latin America, given the still high level of real rates.
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