Global Economic Outlook: A rocky recovery

We came into spring with the wind at our backs as first quarter results were surprisingly strong across the United States, China and Canada. Even Europe, which slipped into recession early in the year, performed better than feared late last year. But as we move through 2023, the impacts of a series of one-off events—be it the unseasonably warm weather that dampened energy demand in Europe, a bumper crop in Brazil, the rundown of excess savings in North America, or China’s post-reopening normalization of activity—aren’t likely to continue to provide much additional support for the global economy.

To be clear, we’re not expecting Global Financial Crisis-type patterns, but perhaps just a whole lot of nothing through the rest of this year, and into early 2024. In our summer Global Economic Outlook, we expect a significant drag on some of the key drivers behind the consumer activity that’s been powering much of the momentum up to now. Interest rate hikes have already led to steep declines in real household wealth over the last six months and higher borrowing costs have taken their toll on the housing market. This will impact consumers’ mood and spending behaviours, through what economists like to call the negative wealth effects.

Additionally, while consumers in the U.S. and in Canada dipped into excess pandemic savings to help finance their spending amid rising costs, much of that cash stash has now been depleted. And what’s left of it is concentrated among the higher income brackets, where the tendency to spend each additional dollar that comes through the door is lowest. In fact, in Canada, if you look at the lower income brackets, where the marginal propensity to consume is highest, they’re actually worse off than before the pandemic.

EDC Economics is also starting to see some deterioration in the labour market, with certain sectors, like consumer discretionary, showing outright declines in employment. This means that job growth should start to pull back as well, especially as higher costs, softening demand, and tighter credit conditions hit corporate earnings. If not, and if employers somehow manage to defy the historical precedent of higher rates leading to higher unemployment, central banks will have no choice but to make it happen. Wage growth in much of the developed world is still running ahead of rates consistent with central banks’ target inflation range. 

While we do expect inflation to come back to target range by 2024, thanks to the lagged effects of interest rate increases, fiscal consolidation, shrinking central bank balance sheets, weaker global demand and the moderating impact of year-over-year price comparisons, prices remain high. And so, elevated wages, and stubbornly high shelter and services costs have forced almost all major central banks to continue to tighten lending conditions, with the notable exception of the People’s Bank of China.

This poses a real challenge for central bankers, given the need to ensure price stability on the one hand, while simultaneously ensuring that they’re not pushing their economies into recession, or igniting financial meltdown. Faced with this policy trilemma, we continue to believe that central bankers are likely to deprioritize growth, even if it means an uptick in unemployment. As a result, we expect the U.S. Federal Reserve and the Bank of Canada to hike rates once more by the fall. The European Central Bank is expected to more than keep pace, under the cover provided by better-than-expected growth in the region.

These moves will weigh on the outlook for the second half of 2023 and into 2024 in advanced economies, especially when combined with the credit impacts of the recent banking turmoil. The anxiety that set into markets earlier this year because of a number of highly publicized bank failures has made lenders more cautious about lending, especially since we don’t know what might trigger the next wave of panic. Together with the steepest hiking cycle in a quarter of a century, this will reduce the flow of credit into the system over the next several quarters and could even bring about contraction in certain economies.

We expect business to ease up on investment and hiring in this environment, as insolvencies increase, thanks to the end of more than a decade of cheap money. As a result, EDC Economics expects U.S. growth to fall to 1.3% in 2023 and just 1% in 2024. Canada’s heavily indebted households will also dial back spending, to service higher debt costs, hitting overall activity and bringing gross domestic product (GDP) growth to 1.2% in 2023 and 1.4% in 2024. In Europe, we expect growth to fall to 0.9% this year and 1.1% in 2024.

China will continue to struggle with the lingering effects of a property slowdown, reduced levels of confidence, record youth unemployment and soft export demand. Authorities there will lean heavily into the economy, but remain constrained by already high levels of local government debt, managing growth of just 5.5% this year and 4.7% in 2024. And with China accounting for 32% of global growth over the last decade, and a big driver of activity in developing markets, this will constrain growth across developing countries, many of which are already suffering from rising debt-servicing costs, weak export demand, and limited room for governments to stimulate growth. Add it all up and we expect a global economy that manages growth of just 2.9% this year and 3% in 2024.

A weaker global demand outlook will weigh on commodity prices. We forecast West Texas Intermediate crude oil prices to average $77 this year and $73 in 2024, as spare capacity and weak demand keep prices in check. Copper prices will also remain subdued, as China’s demand outlook more than offsets growing electrification demand. This, together with the interest rate dynamics described above, will combine to see the Canadian dollar average US$0.74 over our forecast horizon.

The bottom line?

Following two solid years of post-COVID-19 catchup, the global economy has hit a soft patch. While we don’t anticipate a return to the lows of the pandemic period, we expect to see a drag on activity over the next 12 months, before economies stabilize later in 2024. What’s more, downside risk prevails as policy-makers look to skilfully balance the risks in efforts to steer us into open waters.

This week, special thanks to Ross Prusakowski, director of our Country & Sector Intelligence team.

As always, at EDC Economics, we value your feedback. If you have ideas for topics that you would like us to explore, please email us at economics@edc.ca and we’ll do our best to cover them.