FRAGILITY OF FINANCIAL SECTOR MUDDIES IMF’S GROWTH PICTURE
▶ Prospect of continued tightening in developing states a key downside risk for global economy
The International Monetary Fund trimmed its forecast for global growth this year and the next by only 0.1 percentage points to 2.8 per cent and 3 per cent, respectively, in its April 2023 World Economic Outlook.
On the surface, this suggests that not much has changed since the fund’s last update in January, but a closer reading of the report tells a different story. The IMF warned that over the medium term, global growth would probably be the weakest in more than 40 years as tighter financial conditions and high levels of indebtedness weigh on the post-coronavirus recovery.
Moreover, the report notes that the risks to the outlook were skewed to the downside, and the IMF now believes there is an increased probability of a “hard landing” amid high debt levels (particularly in emerging and developing economies), sticky inflation, rising interest rates and elevated financial market volatility.
While the fear of a more widespread US banking crisis has abated for now, uncertainty about the effect of rising rates on banks remains high.
Lending standards, particularly in smaller regional banks, have tightened and this will affect the availability of credit to businesses, investors and consumers. Surveys put the probability of a US recession this year at about 60 per cent.
The US Federal Reserve’s growth forecasts also imply a sharp slowdown in the country’s economy this year to only 0.4 per cent in the fourth quarter. However, there is little evidence in the data so far that the US economy is on the brink of a contraction. The labour market remains astonishingly robust, with unemployment slipping to 3.5 per cent again last month, even as labour force participation rose.
There are some signs that the US labour market is softening. The number of job openings in February fell to the lowest level since April 2021 and initial jobless claims have increased over the past couple of months.
The pace of job gains has also slowed since the start of the year but the absolute levels of these indicators still point to a tight labour market overall.
Non-farm employment increased by 236,000 in March, well above the average monthly job gains in the two years before the pandemic, and there are still 1.7 job openings for every available worker.
Wage growth has slowed to a still-elevated 4.2 per cent year on year, about a percentage point higher than before the pandemic. But it is not only the labour market showing resilience. Survey data shows a rebound in activity in the first quarter, particularly in the services sector, which accounts for the bulk of the US economy. The recent data suggests that there is room for the Fed to raise rates again in May, particularly as core inflation remains stubbornly high.
While the headline consumer inflation reading slowed to 5 per cent in March, from 6 per cent in February, this was largely due to lower energy costs.
Core inflation, which excludes food and energy prices, ticked up to 5.6 per cent annually last month, driven by still-strong services price growth.
A similar case can be made for the European Central Bank and Bank of England to also push ahead with tightening, with inflation in the eurozone and the UK well above the target range, while growth prospects look a little better than they did at the start of the year.
Given the fragilities highlighted by the banking crisis in the US and Europe in March, the prospect of higher-for-longer interest rates in developed economies is a key source of downside risks to the global economy, as highlighted by the IMF. Markets seem particularly focused on these risks and are already pricing monetary policy easing by the Fed in the second half of the year.
The US job market seems to be softening as the number of job openings fell to the lowest level since April 2021