Inflation, Restrictive Monetary Policy to Reduce World Growth – Fitch

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Global inflation pressures continue to intensify, with increasingly adverse implications for the growth outlook, says Fitch Ratings in its Global Economic Outlook (GEO) for June 2022.

Recent lockdowns in China are adding to global manufacturing supply chain pressures. Energy and food supply disruptions from the Russia-Ukraine war are having a swifter impact on European inflation than expected.

Inflation pressures are also building in the services sector, particularly in the US and UK, where tight labour markets are boosting nominal wage growth. Fitch has revised up its inflation forecasts widely and sharply, particularly for Europe in 2H22.

Fitch has lowered our world 2022 GDP growth forecast by 0.6pp since the March GEO to 2.9%. The biggest revision is to China where Fitch now expects growth to fall to 3.7% this year, down from 4.8% in March. Fitch has revised down our growth forecasts for the US by 0.6pp to 2.9% and Eurozone by 0.4pp to 2.6%. Fitch has cut our world growth projection for 2023 by 0.1pp to 2.7%.

The lockdown in Shanghai will lead China’s GDP to fall in sequential quarterly terms in 2Q22 and with the ‘dynamic-zero’ Covid-19 policy still in place, Fitch does not see a swift bounce back. In the Eurozone, inflation will drag on consumers’ real incomes, and German industry is being hit by supply chain disruptions and the China slowdown.

The US economy has near-term momentum, with consumer spending supported by strong growth in jobs and nominal wages. But growth is set to slow from mid-2023 to barely positive rates in quarterly terms on more aggressive monetary tightening. Fitch forecast US growth to fall to 1.5% in 2023 and 1.3% in 2024. Historical experience points to a significant risk of a US recession in the wake of sharp monetary tightening.

“Inflation challenges have become so pronounced that central banks are being forced to respond, abandoning prior forward guidance. The risk of inflation becoming embedded as wage-price dynamics develop and price expectations rise is too big to ignore,” said Brian Coulton, Fitch Ratings’ Chief Economist. Labour markets are very tight in the US and UK, where wage inflation is high and rising as workers resist real wage cuts amid high job turnover.

In this context, Fitch now expect the Fed to raise interest rates to 3.0% by 4Q22 and to 3.5% by 1Q23, that is, above their estimates of the neutral rate and hence to a ‘restrictive’ stance. Fitch also now sees the Bank of England hiking rates to 2% by 4Q22 and 2.5% by 1Q23.

The pace of wage growth has also risen in the Eurozone, though only to 2.8%. But with near-term inflation much higher, Fitch now expects the ECB to raise rates by 100bp this year followed by 50bp in 2023. Fitch sees the ECB main refinancing rate at 1.5% by 2Q23, close to ECB estimates of neutral.