Global Economic Outlook - How Hard Will We Land?

19th October 2023

A report from The Institute for Fiscal Studies.

The fight against inflation continues to dominate the global economic policy agenda.

1. Global growth has so far remained relatively resilient through an extreme surge in inflation paired with one of the sharpest monetary tightening cycles in generations. This suggests that both contracting supply and expanding demand contributed to rising prices and raises a key question for the coming 12 months: have central banks really managed a soft landing of the global economy in such a complex situation? Or is the world facing a hard landing because central banks overreacted to mostly supply-driven inflation, or because they still underestimate the shift in inflation dynamics and will have to go even further to break them?

2. A soft landing is possible. Global inflation has fallen from more than 9% in 2022 to below 6%. Energy disinflation may have run its course, and food inflation is falling. Remaining pandemic-era supply disruptions have faded, suggesting consumer goods will get cheaper. Once wages have adjusted to higher prices, services inflation should also fall. In Europe - but not in the US - we expect inflation to fall below 2% in the second half of 2024.

3. Lower inflation, higher growth? Supply-driven inflation lowers growth, so as it reverses it should stabilise demand while at the same time allowing central banks to cut interest rates. This makes a soft landing more likely, particularly in some emerging markets in Asia and South America, where growth prospects have brightened and central banks are already cutting rates. But the path to a soft landing looks increasingly narrow - especially in the US and Europe.

4. Has the US battle against inflation only just begun? In the US, inflation is expected to stay above 2% beyond 2024. Wage growth is not normalising, and growth and the housing market are picking up despite high interest rates. The risk that the Fed has not yet done enough is significant. While the bar to significant further rate hikes is high, rates may have to stay high for longer to achieve the necessary cooling of growth and inflation.

5. Even in weak-growth Europe, inflation may not return to target quickly. Wage growth is set to remain high and services inflation usually moves in lockstep in both the Euro Area and the US. Wage growth would have to be absorbed by falling profit margins or by rising productivity growth. However, neither has been the norm in recent decades.

6. Despite strong wage growth and fading inflation, we expect the Euro Area economy to shrink for the next three quarters. Weak external demand, labour shortages, uncompetitive energy prices and the housing market are expected to weigh on growth before the full extent of the policy tightening has taken effect. In contrast to the US, there is a significant risk that the European Central Bank has already overtightened. If the Euro Area falls into a protracted recession, and deflationary tendencies return, the ECB would need to react quickly and decisively to avoid returning to the effective lower bound.

7. Global recession? Excluding China, we are now forecasting world GDP growth of less than 1% in 2024, fulfilling some definitions of a global recession. And for China we are not optimistic either. China's economy is struggling to gain momentum as the global manufacturing cycle weighs and structural weaknesses such as demographics and high debt combine with hesitant stimulus.

8. Global interest rates are most likely to fall. Rate hike cycles are coming to an end at 4% in the Euro Area, just over 5% in the UK and just under 6% in the US. Weak growth makes rate cuts most likely from Q2 2024, especially in Europe. In the US, the risks are skewed towards higher rates for longer, however.

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