Threats of recession for the US, Europe and the UK
-Europe. The economic mood of the average European consumer deteriorated significantly as recession risks increased. Morning Consult's Consumer Sentiment Index shows that consumer confidence is waning in much of Europe as Russian President Vladimir Putin's weaponization of natural gas exports has helped fuel an energy crisis and caused utilities prices to skyrocket.
Consumer sentiment has plummeted across Europe after Russia's invasion of Ukraine in February, and has weakened further in recent months, particularly in the UK and Germany. European governments are trying to alleviate consumer pain caused by high energy prices by offering a number of programs, from the €65 billion aid package in Germany to the electricity bill price cap in the UK. However, consumer confidence continues to decline.
While prices are skyrocketing, Western Europeans are often more pessimistic about their country's economic outlook. Over the past 12 months, an increasing proportion of adults in major European economies say they expect to experience 'pervasive episodes of unemployment and depression' over the next five years rather than 'continuous good times'.
“Economic pessimism on the rise among Europeans”… Shares of adults who say their country is more likely to experience “pervasive periods of unemployment and depression” than “continuous good times” over the next five years… Source: Morning Consult Economic Intelligence
A weak economic outlook, combined with rising prices, has put policymakers in a difficult position, but inflation is so high that central bankers feel compelled to act. The European Central Bank recently increased its benchmark interest rate by 75 basis points, and the Bank of England raised another 50 basis points on September 22, despite a depressing economic forecast.
Tighter financial conditions will help alleviate inflationary pressure, but will have a negative impact on investment and growth at a cost. The BoE is now warning of a recession and risks weigh on the downside across Europe. While fiscal policies aimed at supporting households have helped, European consumers are both increasingly restrained and pessimistic; this will likely result in reduced expenditure going forward.
-United Kingdom. S&P estimated that the UK is already in the midst of a 'moderate four-quarter recession that started in the second quarter' as households face 9.9% inflation and are expected to increase further over the winter by cutting consumer spending in the coming quarters.
'The financial support measures implemented by the government, particularly the cap for typical household energy bills ('Energy Price Guarantee'), will significantly protect household budgets from an even greater inflation squeeze over the winter”, said Paul Watters, Head of Regional Credit Conditions at S&P.
However, Watters noted that inflationary pressures are not limited to retail energy prices, and that domestic price pressures will remain high with core inflation – excluding volatile food, energy, alcohol and tobacco prices – as the falling pound pushes the price of imported goods even higher.
S&P expects the Bank of England to respond by raising interest rates from the current 2.25% to 3.25% by February 2023 and sharply cool the economy to return inflation to its 2% target over the medium term.
“Beyond the global and regional risks associated with the Russia-Ukraine conflict, continued or deepening volatility in the sterling exchange rate and gilded markets could lead to more unfavorable financing conditions and worsen the broader economic environment beyond what we currently anticipate,” Watters said.
The sterling hit an all-time low against the dollar, while the UK gilt yields rose as markets pulled back after the new government's controversial so-called 'mini-budget'.
The package of policy measures included tax cuts and energy subsidies to households and businesses estimated to cost at least 9% of GDP by 2026, and the Bank of England responded by reiterating its commitment to further monetary policy tightening to rein in new highs in inflation.
S&P added in its report: “The concern for the Gilt market is that almost 6% of GDP [emergency energy support] will be financed by new debt at a time when the BOE shrinks its balance sheet and the pound depreciation increases inflationary pressures.'
Treasury Secretary Kwasi Kwarteng's tax cut policies drew criticism from US Federal Reserve official Raphael Bostic and former Treasury Secretary Larry Summers, while the International Monetary Fund issued a rare public rebuke.
S&P forecasts annual UK GDP growth of 3.3% in 2022, before contracting 0.4% in 2023.
-United States of America. Many forecasts now call for a recession in the US. In fact, 1Q22 and 2Q22 saw negative growth in the US economy by -1.6% and -0.6%, respectively, according to the latest estimates.
Unfortunately, 3Q22 isn't looking much better with near-zero growth forecasts. We will see the first official forecast of 3Q22 GDP in late October.
The US economy as a whole may not be impressive, but the unemployment situation is relatively good so far. According to the latest unemployment report, US unemployment for August 2022 was 3.7%. This is absolutely low.
Unemployment has failed to fall below 4% in the most recent cycles, so we are in a good place compared to most of recent history. Still, even there there are some concerns. Unemployment has increased slightly compared to the latest figures. This could be an early warning of a recession.
-Recession alerts. Other recession warnings are also flashing. The yield curve, which had a strong history in recession forecasting, has now reversed. Much of what was seen as the all-important relationship between 3-month and 10-year rates has yet to be reversed. Yet the presence of an inverted yield curve may mean that a recession is likely within a year.
The stock market doesn't show much optimism then. Of course, the stock market is volatile and reacts, and perhaps overreacts, to many things, not just the US economy. Still, the current bear market indicates that there may be economic problems ahead.
Policymakers at the Fed have mixed views on the economy. With the latest rise in interest rates, forecasts by Fed policymakers showed many predict higher unemployment in 2023 and some predict negative growth. This could mean that some think a recession is likely.
Overall, Fed policymakers have said in their recent speeches that the current policy of raising interest rates to combat inflation increases the likelihood of a recession in the US, but they won't go so far as to directly forecast a recession.
Hard financial tightening and its slowing effect. Higher-than-expected inflation, especially in the United States of America and major European economies, triggers tightening in global financial conditions. China's slowdown has been worse than expected amid the COVID-19 outbreaks and lockdowns, and the negative effects of the war in Ukraine have been exacerbated. As a result, global production contracted in 2Q22.
The synchronized monetary tightening between countries is historically unprecedented, and its effects are expected to be seen next year as global growth slows and inflation slows. Tighter monetary policy will inevitably have real economic costs, but delaying it will only worsen the challenge. Central banks starting to squeeze should stay on this course until inflation is reined in.
Synchronized tightening… Central banks all over the world are raising interest rates. (Number of increases/decreases in G20 economies (excluding Russia) normalized by average increase/decrease size) Source: Bloomberg Finance L.P., IMF
Rate hikes make borrowing less attractive as interest payments increase. It affects all forms of borrowing, including interest rates on personal loans, mortgages, and credit cards. As savings rates increase in an environment with a tightening policy, the increase in rates also makes savings more attractive.
By pulling down demand completely, it slows down the entire economy.
Conclusion? “Europe faces a difficult and uncertain geopolitical and economic outlook, as Russia's appetite for political risk has increased following territorial losses in Ukraine and exorbitant energy prices have fueled inflation and triggered interventions to support consumers and businesses, as central banks quickly readjusted interest rates.” said S&P.
Tightening fiscal conditions will lead to a further slowdown in global economic growth, risk expansion in fragile regions and deepen anticipated recessions in Europe. The combination of below-average economic growth, rising unemployment and improving supply chain conditions will cause inflation to fall over the next two years.
The outlook has darkened significantly since April. The world may soon be teetering on the brink of a global recession, just two years after the last one. From climate transition and pandemic preparedness to food security and debt relief, multilateral cooperation will be key. Amid great challenges and strife, strengthening cooperation remains the best way to improve economic prospects and reduce the risk of geoeconomic fragmentation.
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