One of the key characteristics of the post-pandemic world is the speed of the business cycle. Over the last three decades – the Great Moderation period – business cycles have been characterized by their duration and relative stability. The economic expansion leading up to the COVID-19 crisis was the longest on record, lasting more than a decade. Today, less than three years after the sudden stop in demand and supply induced by the pandemic, a mild global recession appears to be the consensus view.
The ongoing war in Ukraine and sanctions on Russia; multi-decade high interest rates; depressed global equity prices; elevated market volatility; and a synchronized slowdown in Europe, Latin America, North America, and Asia will likely push the global economy into a recession in 2023. Our view is that global GDP growth will slow from 6% in 2021 to only 1.9% in 2023 — the weakest performance since 1991 outside of the financial crisis and pandemic. We anticipate growth around 3.5% in 2024.
While there is a consensus around a mild recession view, we shouldn’t forget that the profound COVID-19 shock to the global economy and the rapid fiscally stimulated recovery have left a trail of imbalances that will lead to more persistent macroeconomic volatility. If the pandemic has taught us anything, it’s that economic activity is rarely linear. Shifts in supply, demand and policy can be abrupt and will force a proactive and nimble business strategy approach.
Our theme for 2023 is “Transforming global uncertainty into opportunity.” We must be conscious that, going forward, we’re likely to be in an environment where growth will be less robust and more volatile; where inflation will display an upward bias; where interest rates are unlikely to go back down to zero; and where asset prices for commodities, goods, services and labor will display much more volatility than usual.
In this uncertain environment, businesses should be particularly attentive to further disruptions from the war in Ukraine; the evolution of the zero-COVID-19 policy in mainland China; relative monetary policy hawkishness in the US, Canada, UK, eurozone, Latin America and Asia; and growing concerns around debt sustainability, which may constrain governments’ ability to stimulate economic activity and thus prevent any fiscal largesse even if economic activity falters.
Rather than allow the economic environment to dictate business decisions, business leaders should seek opportunities to grow. Business executives must do so by building resilience and adaptability to this new paradigm of uncertainty. More than ever, it’s important to be proactive and seek a better understanding of the outlook and discover how to turn potential pitfalls into new prospects.
Tour d’horizon
- US. The economy continues to display resilience, but underlying momentum is slowing, and recent economic indicators are revealing an increasingly bifurcated economy. While services activity remains robust, the housing sector is tumbling under the weight of elevated mortgage rates, and manufacturing activity is stalling – both signaling a broader economic downturn is likely coming. We expect the combination of persistent inflation, tighter financial conditions and weaker global growth will tip the US economy into a mild recession in H1 2023. We see real GDP flat next year after growing an expected 2% this year.
The main engine of US growth – the consumer – is still running. But as we head into 2023, three key factors suggest it will lose considerable steam. First, the soft income trend will weaken further in 2023 on softer compensation and employment growth. Second, the “savings dip” is unprecedented and unsustainable. Third, the credit splurge is a true risk, especially for families at the lower end of the income spectrum.
With household sentiment historically depressed and savings cushions rapidly dwindling, consumers will likely grow increasingly reluctant to spend in coming months. This will become more apparent as labor market conditions deteriorate and household wealth takes a hit from falling stock prices and declining home values. We forecast consumer spending will flatline in 2023 after a 2.7% advance this year.
Our conversations with executives across a broad range of sectors indicates an impending softening of labor market dynamics as companies face weaker sales domestically and abroad, continued cost pressures, and tighter financing conditions. We expect the economy will add around 4.4m jobs this year but lose around 2.0m jobs in 2023, with the unemployment rate rising toward 5.2% by midyear.
Consumer price inflation (CPI) and producer price inflation (a proxy for business margins) will turn lower with accelerating momentum in 2023. We continue to expect headline and core CPI will decelerate gradually through early 2023, remaining above 4% until mid-2023, but they will approach the Fed’s 2% inflation target by year-end.
Fed Chair Jerome Powell recalibrated monetary policy by adopting a new destination paradigm — indicating an intention to reach a higher terminal fed funds rate while doing so at a slower pace. The difficulty for the Fed will be to prevent an excessive and counterproductive loosening of financial conditions in the face of weaker-than-expected inflation. We believe the Fed will aim to bring the federal funds rate toward 5% (or slightly above), at which point we believe it will pause to evaluate economic and financial market conditions
- Eurozone. We believe elevated inflation and a lingering energy crisis will lead to a moderate recession in the eurozone. Mild temperatures, robust employment growth and fiscal programs to help alleviate the burden of high energy prices on households have translated into relative economic resilience in Q3. However, depressed business and consumer sentiment, increased industrial sector weakness in Germany and France, and softness in consumer spending trends ahead of the holidays indicate the eurozone is entering a recession. We expect eurozone real GDP will contract 0.6% in 2023, after a modest 3.0% expansion in 2022.
While inflation will likely ease over the course of 2023, it remained extremely high at 10% year over year (y/y) in November. With energy supply disruptions still a clear possibility and demand highly dependent on the severity of the winter, energy rationing and accelerating inflation remain important risks. The European Central Bank (ECB) slowed the pace of monetary policy tightening at its December meeting but presented a hawkish view and will likely proceed with at least another 100 basis points (bps) of rate hikes in 2023.
- UK. In the UK, double-digit inflation and elevated interest rates will significantly constrain consumer spending over the course of 2023. While the currency has stabilized, and gilt and stock market dislocations from October have now mostly reversed under Prime Minister Rishi Sunak’s more fiscally conservative policies, the economy will suffer a recession over the coming months. The tighter fiscal policy stance will entail less support to economic activity while elevated mortgage rates will lead to a prolonged housing correction. We expect UK real GDP will fall by 0.9% in 2023 with the Bank of England continuing to tighten monetary policy by raising the policy interest rate toward 4%.
- Japan. In Japan, the improving health situation and easing supply chain disruptions led to greater consumer spending activity and rebounding business investment in the fall. But, while moderate growth momentum is expected through 2023, a sluggish global economic backdrop will limit the upside to growth. Inflation is expected to cool from above 2% to around 1% in the absence of wage growth pressure, despite the upward pressure from the yen weakening. As such, we don’t foresee much change in the monetary policy stance. We see real GDP growth around 0.4% in 2023 after a 1.7% advance in 2022.
- Mainland China. The economic outlook for mainland China remains uncertain, with growth constrained by the zero-COVID-19 policy, a lingering property sector downturn and weakening global trade activity. A gradual relaxation of COVID-19 restrictions along with more broad-based vaccinations represent an upside risk to growth along with increased stimulus measures aimed at supporting property sector investment. We anticipate real GDP growth will rebound from around 2.9% in 2022 to 4.0% in 2023, providing a welcome offset to the lackluster global backdrop. Upside risks to global growth and inflation from a more rapid relaxation of zero-COVID-19 polices are worth monitoring.
- Emerging markets. In emerging markets, economic activity is constrained by high inflation and tight monetary policy along with slower growth across advanced economies and mainland China. We anticipate ongoing weakness through the first half of the year as these factors continue to constrain growth, but we note the upside risk to growth for emerging economies in Asia from mainland China’s potentially accelerated loosening of COVID-19 restrictions and rebounding tourism activity in the latter half of 2023. Activity across Latin America will likely be sluggish in 2023, with Brazil and Mexico real GDP advancing less than 0.5% on elevated inflation, tight monetary policy and fiscal tightening policies.