Global economics: risks tilted to the downside, but consumers are in the driving seat

Slowdown or slump? The jury is still out. The picture being painted is increasingly bleak but there are nuances to the story.

Written By:

Flora Harley, Knight Frank

06 Sep 2022

4 minutes to read

Categories: Topic Economics

The July World Economic Outlook painted a drearier picture with a forecast of a halving in GDP growth this year to 3.2%, down from the 6.1% seen in 2021.

The expectation is that this will slow further to 2.9% in 2023 as contractionary monetary policy begins to bite. Global output contracted in the second quarter of this year with weaker growth in many large economies.

Unfortunately, as pointed out by the IMF the ‘risks [are] overwhelmingly tilted to the downside’, especially as we are unlikely to see an end to the conflict in Ukraine in the near-term. But there are mixed signals everywhere.

GDP not telling full story and labour markets continue to defy

Despite two consecutive quarters of economic contraction in the US, an expanding labour market, among other indicators, contradicts the recession narrative.

So far in 2022, 470,000 new jobs have been created on average each month. For context, in 2008 job losses began in January predating the official beginning of recession in Q3. Other indicators which the NBER, the organisation which categorises recessions in US, look for paint a mixed picture but one that suggests a slowdown from the rapid bounce in 2021 rather than a reversal.

Consumers hold the balance between slowdown and slump

Consumer who account for the lions share of GDP, hold the key, notes UBS Chief Investment Officer, Paul Donavan. “But consumer reaction functions are not normal, consumer balance sheets are not normal, and the labour market is just weird.”

Consumers are the most pessimistic the pandemic

Yet their actions, i.e. spending, tell a different story. Retail sales excluding cars and fuel surprised on the upside in the US, despite consumer confidence at lows not seen since February 2021. Meanwhile, on the other side of the pond, the UK's headline retail sales figures also rose on both a monthly and annual basis, despite confidence being at its lowest ebb since the mid-70s.

Balance sheets are healthier than any other downturn

Whilst that remains the case, we may see consumption diverted as cost-of-living pressures continue to grow. Excess savings, whilst dwindling a little, remain strong. For example, at the end of Q1 households held an estimated £185bn in excess savings in the UK and $3.2 trillion in the US.

This is one measure we will continue to watch as inflation climbs to new highs; CPI currently stands at 8.9% in the Eurozone, 8.5% in the US and 10.1% in the UK in July.

There are tentative signs of respite in the US

Europe and the UK the peak is not there yet. Wholesale gas prices rose to more than €330/MWh from under €100/MWh at the start of 2022 and around €40/MWh at the beginning of 2021, at time of writing they had receded to around €260/MWh.

The security of supply is starting to weigh on sentiment. The Nord Stream 1 pipeline was running at 20% capacity, and will now not reopen following the shutdown at the end of August ‘until Europe lifts sanctions’. There may be some rationing across the continent, and it is likely we will continue to see energy supply pressures feed through to inflation.

Interest rates continue to climb increasing debt cost

This may alleviate in a years’ time. The Federal Reserve has raised the interest rate by 225bps so far in 2022 and more is to come – maybe another 75bps in September. Consensus is that with cooling economic growth, as long as inflation subsides, central banks will be forced to pause or reverse in the middle of 2023 – although central bankers after the annual gathering in Jackson Hole indicated that higher rates are here to stay.

It is clear economic headwinds, or storms, are gathering with few, but some, bright spots. The inflation and interest rates story clearly has further to run later this year and will likely dominate headlines in 2023 as well.

But should inflation lose steam and labour markets remain healthy, it will be bumpy ride but not a cliff-edge. Which forces will win out will only become clearer with hindsight.