World economy is not expected to enter a recession but...

The global economy is facing a period of weak growth, persistent inflation and heightened risks. In 2023, tighter monetary policy and higher real interest rates, combined with higher energy prices, weak household income growth and declining confidence, weigh on growth. Based on the bleak picture, job losses may be less than expected, but that is because businesses want to keep their workers as they have struggled to recruit the right people after the pandemic.

Savings built up during the pandemic provide some buffer to households and businesses. However, the distribution of these savings is uneven, and household savings rates are expected to decline significantly in many of the advanced economies. Real income growth is not likely to accelerate until next year when inflationary pressures are expected to ease, thus giving room for monetary easing steps in North America, Europe and many emerging economies.

The outlook in the Asia/Pacific region is somewhat better, as many countries have relatively low inflation and pro-business policies. Growth in China is expected to be stronger than in America or Europe. Europe is still affected by the effects of the war in Ukraine and high energy prices, which are unknown for how long they will continue. Output is expected to decline in the near term in many European countries, including Germany, Italy, the United Kingdom and many euro area countries.

In North America, high inflation and rising interest rates are constraining growth. In the United States, real wages have fallen, and monetary tightening has pushed up interest rates to a point that is weakening investment, especially the housing market. Higher interest rates also led to a stronger dollar, driving export activity in the opposite direction.

USA

According to the OECD, US GDP growth is forecast to slow to 0.5% in 2023 before picking up to 1.0% in 2024, while core inflation is expected to return to near the Federal Reserve's 2% target towards the end of 2024, allowing for some easing of monetary policy.

Japan

Fiscal policy is forecast to be more accommodative in 2023 but then tightened in 2024. According to the OECD, GDP growth is expected to be 1.8% in 2023 and 0.9% in 2024. The unemployment rate to continue to decline in 2023-24, reaching 2.4% and the further tightening of labour markets is reflected in the projected increase in structural inflation from 0.3% in 2022 to 1.6% in 2023 and 1.7% in 2024.

Korea

Weak external demand is a major factor in the projected slowdown in Korea, along with modest growth in disposable income and a soft housing market. GDP growth is expected to slow to just under 2% in 2023 and 2024. Inflation will remain high for some time in 2023 due to pressures on the prices of services and utilities but will gradually moderate to less than 2% until the end of 2024.

EU

Weighed down by high energy and food prices, weak confidence, continued supply bottlenecks and the impact of tighter monetary policy, annual growth in the euro area in 2023 is forecast to be 0.5% before rising to 1.4% in 2024 as spending begins to recover. The implementation of next-generation EU plans should support investment. A mild increase in demand will help contain inflation. However, tight labour markets and the prospect that high wholesale energy prices will continue to feed retail prices in 2023 and 2024 mean that inflation will ease gradually, remaining above the 2024 target.

United Kingdom

Higher energy and food prices and weak confidence are weighing on the UK, where output is forecast to contract 0.4% in 2023 and rise just 0.2% in 2024, with tighter fiscal policy limiting the recovery. As in the euro area, lower demand is expected to contribute to a steady decline in inflation, to 6.8% in 2023 and 3.4% in 2024.

China

In China, as residential investment remains weaker, growth in 2023 and 2024 will be sustained by infrastructure investment and other measures to moderate the correction in the real estate sector. According to the OECD, GDP growth is forecast to rise to 4.6% in 2023 before slowing to 4.1% in 2024. Consumer price inflation is expected to remain favourable, helped by the current energy and food management policies. The other major Asian emerging market economies are forecast to be relatively resilient next year and have only a modest and short-lived overshoot of inflation targets.

Latin American

Major Latin American economies performed better than expected in 2022, with food and energy exporters, in particular, benefiting from improved terms of trade. That recovery is expected to lose momentum in 2023 and 2024 amid tighter global and domestic financial conditions, the withdrawal of most remaining fiscal support and less bullish commodity prices.

Risks remain high

According to the OECD, amid slowing global trade and tighter monetary conditions, annual GDP growth is expected to weaken in 2023 in most advanced and emerging economies before recovering somewhat in 2024. Although global economies are not expected to enter a recession, the fact is that there are increasing risks. Rapidly rising interest rates, tighter global financial conditions and significant asset revaluations could expose both advanced and emerging economies to long-term financial vulnerabilities.

For households and businesses, a sharp rise in interest rates puts their ability to service their debts at risk:

Housing market

In the housing market, bankruptcies and house price corrections are possible. The proportional housing price to income is at record levels in most OECD countries, with prices, although from very high levels, already starting to decrease in some countries. Population growth and rising disposable income are the most important long-term drivers of house prices, although higher real interest rates could moderate the price rise. Those who are particularly vulnerable are low-income families who are over-indebted and widely use variable-rate mortgages, as is the case in some Nordic countries.

Companies

In the corporate sector, rising interest rates can expose them to financial vulnerabilities. Although sovereign debt maturities have been lengthened during the pandemic, the share of companies unable to service debt payments could rise sharply if central banks tighten policy further.

Banking sector

The increased pressure on households and companies and the possibility of loan defaults raises risks of significant potential losses for banking and non-financial institutions. Stress tests generally suggest that tighter regulatory measures since the global financial crisis have helped improve the banking sector's resilience to shocks. However, many banks could still face significant losses if a larger-than-expected economic slowdown occurs, especially in emerging market economies where banks are susceptible to shocks and typically have lower capital ratios than in advanced economies.

Focus of investors and traders

In conclusion, although there are no strong indications that there will be a global recession, at the same time, we are facing a challenging economic outlook. Growth will be sluggish for the global economy in 2023, while high inflation will be difficult to reduce in many countries.

In these complex and uncertain times, much will depend on the policies that will be implemented as they will play a crucial role in the future of economies and markets. Thus, a further tightening of monetary policy is required to combat inflation alongside well-targeted support through fiscal policy.

The situation will improve if investments in adopting and developing clean energy sources and technologies are accelerated, as they will be crucial for diversifying the energy supply and ensuring energy security, especially in Europe. A focus is also needed on structural policies enabling policymakers to promote employment and productivity to make growth work for all.

In other words, much will depend on policymakers if they choose the right policies, and that is where investors and traders will need to focus, as commodities, FX, and stock prices will be directly affected by these policies, both in terms of short-term and long-term prospects.