The International Monetary Fund (IMF) downgraded its outlook for the global economy next year based on the effects of the war in Ukraine, global inflation that requires interest rate hikes and a slowdown in China.
“In short, the worst is yet to come, and for many people 2023 will feel like a recession,” IMF Chief Economist Pierre-Olivier Gourinchas stated.
The IMF, which is the primary financial institution of the United Nations, now forecasts global growth will slow next year by 2.7% — down from 2.9% estimated back in July and down from the 3.2% growth projected this year.
Gourinchas said that there is about a 25% probability that global growth in 2023 could be at about 2% while there's a 10%-15% chance that actually output growth could be even lower than 1%.
“2% is a very low number," Gourinchas told Yahoo Finance Live. "We only had that about five times since 1970. And every time we had this, if you look, it's 1973 the oil price shock, 1981 and the Volcker disinflation, the 2008 financial crisis. They are all stuck in our collective memory as times of difficulties.”
More than a third of the global economy is expected to contract this year or next, while the three largest economies — the United States, the European Union, and China — will continue to stall.
The IMF expects growth in the U.S. to clock in at 1.6% this year — 0.7% lower than its July forecast — and growth of 1% in 2023.
Russia’s invasion of Ukraine continues to destabilize the global economy, the IMF noted, leading to a severe energy crisis in Europe that’s sharply increasing costs of living and hurting the economy.
The IMF warns that the risk of monetary, fiscal, or financial policy miscalibration has risen sharply and financial markets are showing signs of stress. The IMF believes that over-tightening risks pushing the global economy into an unnecessarily harsh recession.
At the same time, the IMF noted that it’s important for countries to raise rates and bring inflation under control since front-loading rate hikes and aggressive monetary tightening is critical to keep long-term inflation expectations in check. Overall, the IMF endorsed the Federal Reserve’s approach to monetary policy.
“We are very comfortable with the monetary policy that is currently envisioned by the Federal Reserve and that is priced into markets,” Tobias Adrian, the IMF’s director of capital markets and monetary policy, told Yahoo Finance Live. “We think that this is what is needed in order to get inflation down. To get inflation down, you need to slow economic activity to some degree. Hopefully this will be a soft landing or even if it [were] to be a recession, it could be a shallow recession."
Adrian added that "we could see a more severe recession."
The IMF is forecasting global inflation to peak in late this year, but to remain elevated for longer than previously expected. The IMF sees inflation at 8.8% this year, then declining to 6.5% next year before decreasing to 4.1 percent by 2024.
“Inflation keeps going up still,” Gourinchas told Yahoo Finance Live. “I mean, we're expecting that it's going to peak soon and then start going down as a result in part of actions by central banks. But it's proven both more persistent, more elevated, and also broader.”
The IMF also warned that risks to the stability of the global financial system have “materially worsened.” The international body said market liquidity has deteriorated across key asset classes and that there is a heightened risk of rapid, disorderly repricing which could interact with — and be amplified by — pre-existing vulnerabilities and poor market liquidity.
The IMF’s Global Bank Stress Test showed that a scenario with an abrupt and sharp tightening of financial conditions would send the global economy into recession in 2023 amid high inflation.
And while the Bank of England intervened in government bond market for the second time in 24 hours to shore up its bond markets in the wake of rising interest rates and potential changes in fiscal policy, Adrian said that the IMF believes the UK’s situation is special to the UK and doesn’t see the potential for contagion, nor does the international body see similar activity else where at the moment.
“While the rise in interest rates has moved some degree with other interest rates," Adrian said, "interest rates tend to move together, we haven't seen a spillover in terms of market dysfunction. Most of the tightening has been done within orderly market conditions. ... Having said that, there is certainly a risk of disorderly tightening at some point.”
Cleveland Fed President Loretta Mester echoed that sentiment at the Economic Club of New York on Tuesday, saying that the Fed has to "look for vulnerabilities as we’re increasing rates and [as] globally a lot of central banks are raising rates. There’s no evidence of disorderly market functioning at present.”