The current economic outlook poses significant challenges and a high degree of uncertainty. Various tensions within the financial sector have the potential to amplify and weaken the real economy. This situation could lead to a severe deterioration in financing conditions, prompting central banks to reassess their policies.
Moreover, it is anticipated that sovereign overindebtedness pockets will extend and become more systemic, particularly with higher borrowing costs and lower economic growth.
The conflict in Ukraine is another factor that could escalate, leading to increases in food and energy prices, and pushing inflation upwards.
Persistent challenges
- One of the persistent challenges in the economic landscape is underlying inflation, which could prove more enduring than initially anticipated. This would necessitate further monetary adjustments to keep it under control. Additionally, fragmentation into geopolitical blocs could also lead to significant production losses, including a negative impact on foreign direct investment. In this context, policymakers face a complex task of improving economic prospects and minimizing risks. Central banks must maintain a firm and focused stance on combating inflation, while also being prepared to adjust their policies and utilize all available instruments to address concerns regarding financial stability.
- Meanwhile, fiscal authorities must support the measures undertaken by monetary and financial authorities, aiming to achieve a return of inflation to the established target while maintaining financial stability. In cases where it is fiscally feasible, governments should pursue a generally strict posture while providing specific support to those facing greater difficulties due to the cost of living crisis.
- In situations of severe disadvantage, full functioning of automatic stabilizers should be allowed, and temporary support measures should be implemented as necessary, provided there is fiscal space to do so. In the medium term, debt sustainability will require timely fiscal consolidation, and in some cases, debt restructuring may be necessary.
- It is important to allow currencies to adjust to changes in economic fundamentals, although in circumstances of imminent crisis, implementing capital flow management policies may be justified to prevent a sudden outflow of capital, without replacing the need for necessary macroeconomic adjustments.
- On the other hand, it is essential to take measures to address the structural factors that hinder supply and limit medium-term growth. These measures could include reforms aimed at improving the efficiency and competitiveness of labor markets, as well as investments in infrastructure and education.
The global economy could achieve a soft landing
Tentative signals in early 2023 that the global economy could achieve a soft landing, with declining inflation and steady growth, have faded amidst persistently high inflation and recent turbulence in the financial sector.
Although inflation has subsided as central banks have raised interest rates and food and energy prices have declined, underlying price pressures are proving difficult to control, especially with tight labor markets in several economies.
Underlying pressures on prices are proving difficult to control, especially with tight labor markets in several economies.
The side effects of the rapid increase in policy rates are becoming increasingly evident as vulnerabilities in the banking sector come to light, and fears of contagion have increased throughout the financial sector, including non-bank financial institutions. In response, authorities have taken decisive measures to stabilize the banking system. As discussed in-depth in the Global Financial Stability Report, financial conditions fluctuate with changes in sentiment.
Simultaneously, the other major forces shaping the global economy in 2022 appear to remain present this year, albeit with varying intensities.
- Debt levels remain high, limiting fiscal authorities' capacity to respond to new challenges.
- Commodity prices, which sharply increased following the Russian invasion of Ukraine, have moderated, but the war still persists, and geopolitical tensions remain elevated.
Despite the mentioned challenges, there are signs of economic recovery on the horizon. COVID-19 infectious strains caused widespread outbreaks last year, but economies that were severely affected, especially China, appear to be on a path to recovery, which has alleviated disruptions in supply chains.
In this scenario of economic and financial uncertainty, it is crucial for investors and decision-makers to be prepared to face potential challenges and seize emerging opportunities.
Market volatility can generate risks, but it also opens the door to potential gains. Therefore, having a solid and diversified investment strategy that takes into account different scenarios and adapts to changes in economic and financial conditions is essential.
Market volatility can generate risks, but it also opens the door to potential gains.
Additionally, it is crucial to pay attention to the decisions of central banks and the fiscal policies implemented by governments, as these measures can have a significant impact on the markets and the economy as a whole.
The risks are firmly tilted to the downside.
Economic prospects face significant challenges stemming from lower food and energy prices, as well as improved supply chain functioning. However, the risks are firmly tilted to the downside due to increased uncertainty caused by recent turmoil in the financial sector.
According to the baseline forecast, assuming current financial sector tensions remain under control, global growth is expected to decrease from 3.4% in 2022 to 2.8% in 2023 before gradually increasing and stabilizing at 3.0% over the next five years. This medium-term forecast represents one of the lowest growth rates in decades. Advanced economies are expected to experience a particularly pronounced slowdown, with growth declining from 2.7% in 2022 to 1.3% in 2023.
Global growth is expected to decrease from 3.4% in 2022 to 2.8% in 2023.
However, in a plausible alternative scenario with increased financial sector tension, global growth could decrease to around 2.5% in 2023, which would be the weakest growth since the global slowdown in 2001, excluding the initial COVID-19 crisis in 2020 and the global financial crisis in 2009. In this scenario, growth in advanced economies would be below 1%.
This anemic economic outlook reflects the restrictive policies necessary to combat inflation, the consequences of recent deterioration in financial conditions, the ongoing conflict in Ukraine, and the increasing geoeconomic fragmentation.
Global headline inflation is expected to decrease from 8.7% in 2022 to 7.0% in 2023, primarily due to lower commodity prices. However, underlying inflation is likely to decrease at a slower pace. It is estimated that achieving inflation targets set by central banks will not be accomplished before 2025 in most cases. Once inflation rates return to target levels, deeper structural drivers are likely to reduce interest rates to pre-pandemic levels.
Risks to economic prospects are strongly biased to the downside, and the possibility of a hard landing has increased significantly. This emphasizes the importance of adopting appropriate policies and measures to mitigate risks and promote financial stability.
One of the challenges expected to persist in the economic landscape is underlying inflation, which may prove more persistent than initially anticipated. This would require additional monetary adjustments to keep it under control. Moreover, geopolitical block fragmentation could also lead to significant production losses, including a negative impact on foreign direct investment.
Monetary Policy
In this context, policymakers face a complex task of improving economic prospects and minimizing risks. Central banks must maintain a firm and focused stance in combating inflation but also be prepared to adjust their policies and utilize all available instruments to address concerns about financial stability.
Meanwhile, fiscal authorities must support the measures undertaken by monetary and financial authorities, aiming to achieve a return of inflation to the established target while maintaining financial stability. In cases where it is fiscally feasible, governments should pursue a generally strict posture while providing specific support to those facing greater difficulties due to the cost of living crisis.
In situations of severe disadvantage, full functioning of automatic stabilizers should be allowed, and temporary support measures should be implemented as necessary, provided there is fiscal space to do so. In the medium term, debt sustainability will require timely fiscal consolidation, and in some cases, debt restructuring may be necessary.
It is important to allow currencies to adjust to changes in economic fundamentals, although in circumstances of imminent crisis, implementing capital flow management policies may be justified to prevent a sudden outflow of capital, without replacing the need for necessary macroeconomic adjustments.
On the other hand, it is essential to take measures to address the structural factors that hinder supply and limit medium-term growth. These measures could include reforms aimed at improving the efficiency and competitiveness of labor markets, as well as investments in infrastructure and education.
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