The US and broader global consumer and services sectors will remain robust for slightly longer than we had previously anticipated, given the ongoing willingness to draw down excess savings, the resilience of labor markets, and the real-terms boost households will soon get from lower headline inflation. Certainly, the weakness in manufacturing and housing activity in the US that started in Q4 last year does not seem to have been the usual early warning signal of a wider recession. Instead, it has remained largely consigned to those sectors, and there are even signs that housing activity may be starting to recover.
Against this, we expect ongoing stresses in the banking sector amid higher interest rates, although we don't anticipate a systemic financial crisis. Nonetheless, credit conditions will continue tightening – a headwind to growth that will build over time. Headline inflation will continue to drop sharply over the next 12 months driven by energy base effects and lower food inflation, albeit with some volatility and cross-country differences. Indeed, by late-2024, headline inflation rates in many economies will be around target.
Chart 1. Resilient global economic activity, for now
Source: Haver, abrdn (June 2023)
Core inflation will also decline from here, as it has already started doing in the US, Eurozone, and many emerging market (EM) economies. However, this will be mostly driven by global goods disinflation in the first instance. We think core services inflation will remain sticky amid tight labor markets and strong wage growth.
Indeed, a recession is ultimately necessary to bring core services inflation back to target-consistent rates in the US, many other developed markets (DM), and parts of EMs. We think this is a price central banks are willing to pay to deliver on their mandates and maintain the credibility of inflation targets in the future.
This means that central banks still have a small amount of additional monetary policy tightening left to do. We are forecasting a Federal Reserve (Fed) rate hike in July after skipping the June meeting. This is likely to be signaled at the June meeting with the updated Summary of Economic Projections to show one further rate increase this year.
Chart 2. Core inflation turning lower, but still sticky
Source: Haver, abrdn (June 2023).
We think the European Central Bank (ECB) and the Bank of England (BoE) will both deliver two more hikes. The latest European inflation data should take some pressure off the ECB to continue its tightening cycle much further than this. However, the risk to our BoE forecasts is more clearly skewed to the upside, with ongoing inflation persistence potentially forcing the Bank to tighten further despite the clear desire of policy makers to draw the hiking cycle to a close as quickly as possible.
In Japan, we expect the Bank of Japan (BoJ) to deliver effective monetary policy tightening this summer via changes to the yield curve control (YCC) framework, allowing the 10-year JGB yield to trade up to 75bps. Past tweaks to YCC reflected concerns about market functioning, which have since diminished. Instead, in a striking change to the Japanese macroeconomic environment, we think the BoJ will now be tightening policy directly in response to a pick-up in underlying inflation pressure.
We continue to think this large monetary tightening cycle will ultimately generate recessions in the major DM economies and parts of EMs. The manufacturing sector in many economies is already in contraction. However, amid broader data resilience, we now think the timing of economy-wide recessions will be somewhat later than we had previously anticipated, beginning around the turn of the year. There are cross-country differences in the timing of the respective recessions we are forecasting, with the UK downturn beginning as soon as Q2 (albeit in part due to a technical quirk of the data), the Eurozone expected to be in recession by Q4 this year, and the first negative quarterly GDP print in the US in Q1 next year.
Chart 3. Rates to get a little higher, but then fall sharply in 2024 amid recessions
Source: Haver, abrdn (June 2023)
That said, our conviction around the precise timing of the US downturn is less strong than our conviction that this cycle will end with a policy-induced recession over a time horizon that is relevant for investment decision making. We think policy only became contractionary in the US around the middle of last year, when the real policy rate started to exceed our estimate of the equilibrium real rate. The “long and variable” lags of monetary policy mean that the impact of that tightening is only now starting to be felt in earnest, with the effects set to build through the second half of this year. This is the same signal as our recession probability models are providing, with near-term risks having declined as data has been solid, but longer horizon models remaining elevated due to the deep imbalances in the US economy.
It is plausible that the economy could remain even stronger than we expect through the rest of this year, with a tight labor market supporting household spending. However, we think such a “no landing” scenario is unsustainable as the Fed would be forced to take another “bite of the cherry”, pushing up rates much further in an effort to squeeze out the inflationary excess in the economy. In this scenario, the recession is merely delayed rather than avoided. In our base case, we think monetary policy cutting cycles will begin by early 2024 and continue throughout that year as headline inflation drops and growth is negative. We ultimately expect interest rates to fall below neutral and by more than markets price. This is consistent with how theory and history suggest central banks behave, with large and rapid easing cycles the norm once an economy has entered a recession and unemployment is increasing.
The easy gains of China’s re-opening recovery are over. However, we still forecast above-target GDP growth in 2023 given the room for consumption, travel, and services activity to return to pre-pandemic norms. But manufacturing, trade and investment will continue to struggle, which means much smaller global economy spillovers than typical Chinese recoveries. With inflation rates very low, there is scope for modest policy easing. While many EMs were early to the rate hiking cycle, they will have to wait until 2024 for underlying inflation to cool enough to allow rate cuts to begin. LatAm is best placed to cut given high real rates. APAC benefits from a less challenging inflationary environment, but lower policy rates require a ‘wait and see’ approach. CEE’s lack of central bank credibility amplifies the still substantial inflation problem, implying the region will be the last to cut rates.
The most likely alternative scenario is still a soft landing. One way of reading the US labor market data is that a benign loosening – that can reset wage growth and lower inflation expectations without a recession – is already underway. But we still think that historical precedent argues in favor of a recessionary baseline.
US growth has been more resilient than anticipated in the face of Fed policy tightening and banking sector stress. Consumers continue to spend at a solid clip, helped in part by still large stockpiles of pandemic era savings, and the labor market remains tight. Even those aspects of activity worst affected by rising rates last year – such as housing – have stabilized somewhat. We still think a recession is coming but have pushed the start date of this out to the turn of the year, consistent with our tracking of short-term data and the signals from our recession probability models.
Inflation continues to run at very strong rates. While headline has fallen due to slower energy and food price inflation, there has been limited progress in cooling core price pressures, with the Fed's preferred measure moving sideways (see Chart 4). These dynamics reflect excess demand in the economy, particularly the labor market, which continues to deliver strong wage growth. Excess demand looks set to persist a little longer, given our delayed recession call, meaning underlying services inflation should remain robust through 2023. But we think these pressures will ease quite sharply next year as a downturn takes hold.
Chart 4. Limited progress on lowering inflation
Source: Haver, abrdn, June 2023.
The Fed has signaled it will leave policy unchanged in June, breaking a run of 10 consecutive hikes. Certainly, there is a desire to see how past tightening and banking stress are affecting the economy. But, with activity to remain solid for now, and price pressures hot, it seems likely a pause will be temporary. We are penciling in a 25 bps hike in July, with risks tilted towards more hikes should data remain robust. Once it is clear a recession is taking hold, we expect rates to be cut, and to fall from January 2024 to a low around 1%.
ActivityUK GDP grew by just 0.1% in the first quarter. While industrial unrest weighed on activity, the underlying picture is one of sustained stagnation. And we expect recession-like conditions to continue. Much of the impact of monetary tightening by the BoE is yet to be felt. The combination of this domestic tightening and the spillovers from US and European weakness will weigh heavily on activity. Such a downturn is ultimately necessary to ease the UK's economic imbalances, albeit the primary source of these imbalances seems to be weak supply rather than strong demand.
The April inflation report painted a very concerning picture of the extent of the UK's inflation problem. The headline rate fell by less than expected, dropping from 10.1% to 8.7% (see Chart 5). This decline was almost entirely due to favorable base effects around the energy price increase in last April, and headline inflation should continue to fall further this year even if elevated food price inflation slows this fall. More concerningly, underlying inflation pressures seem to be picking up, with core inflation up from 6.2% to 6.8% and services inflation increasing from 6.6% to 6.9%.
Chart 5. UK core inflation has picked up and headline inflation is falling slower than expected
Source: Haver, abrdn, June 2023
The strength of April's inflation report makes it very likely that the BoE will hike interest rates a further 25bps in June, to 4.75%. Another labor market and inflation report, due to be released before the next policy meeting, could plausibly change the picture again. But we now think the Bank will need to push rates up to at least 5% to tackle underlying inflation pressures. This is likely to eventually tip the economy into a recession, at which point monetary policy will start to ease, with rates falling below what is priced by markets.
The economic data is sending mixed messages. GDP growth in Q1 2023 was 0.1% quarter over quarter, but Germany fell into recession. The composite PMI survey slipped to 53.3 in May, but this still points to a further GDP growth acceleration over Q2 (see Chart 6). The industrial sector is still in contraction, bank lending conditions are tightening, loan growth is weakening, and retail sales are slipping back. We expect the growing drag from the ECB's rate hiking cycle to drive the economy into recession from Q4 2023.
Chart 6. Surveys point to a rebound in Eurozone activity, although this won’t last
Source: Haver, abrdn, June 2023
Inflation is dropping back but remains very elevated. Headline inflation fell to 6.1% year over year in May and will continue falling sharply as energy base effects moderate. Core inflation also ticked lower to 5.3% and should continue to fall modestly on global disinflationary forces in the goods market. But core services inflation, generated by all-time lows in the unemployment rate and strong negotiated wage rounds, is unlikely to return to target-consistent rates without an eventual rise in unemployment.
The ECB is still in rate-hiking mode. It increased the deposit rate by 25 bps to 3.25% in May, and clearly signaled that it “is not pausing”. We are expecting a 25 bps hike in June and another one in July given the hawkish rhetoric. However, the recent decline in inflation means that the September rise that some hawkish Governing Council members have been advocating for seems unlikely. A recession would ultimately mean a rate cutting cycle during 2024.
Q1 preliminary GDP beat expectations as strength in consumption and investment helped offset softer trade activity. Spending has remained resilient following the reopening rebound, helped by an increase in inbound tourist consumption. Consumer strength should continue to support growth in the coming months and fuel speculation over domestically generated inflation. But the global outlook will also weigh heavily on Japan’s growth as spillovers from a US recession may outweigh the impact of the expected recovery in tourism from China.
While headline inflation appears to have lost some steam, core inflation continues to accelerate, driven by services (see Chart 7). Dining out and hospitality-related sectors have underpinned this acceleration. The BoJ will likely raise its inflation forecasts in July and may even signal that a sustainable return to its 2% target is within sight. Governor Ueda’s communication has been balanced. He has tempered enthusiasm over the recent strength in wage negotiations, stating that next spring’s Shunto wage hikes would be important in confirming the sustainability of wage growth. However, recent inflation data support a summer policy adjustment.
Chart 7. Strong service sector demand drives underlying inflation
Source: Haver, abrdn, June 2023
The BoJ left policy settings unchanged at the April meeting, but finally dropped dovish Covid-related forward guidance. The announcement of a 12- to 18-month review of the monetary framework was considered dovish by investors, as it suggested the BoJ is in no rush to change policy settings. However, Governor Ueda confirmed that the necessary shifts would be made regardless of timing. We think the most likely change will be a widening of the tolerance band around the 10-year JGB trading range to at least +/-75bps either in June or July.
A soft start to Q2 – with some notable weakness in manufacturing, property, and trade – raises doubts about the strength of China's recovery through 2023. However, the normalization of the consumption rate should still be a major engine of growth, even if excess savings are not tapped. Indeed, the services sub-index in our China Activity Indicator remains at a high level, consistent with a slower but ongoing recovery (see Chart 8). The later timing of the US recession reduces risks for 2023 but pushes the shock into 2024; hence, we expect 2023 GDP will come in above consensus at 6%, while 2024 will disappoint.
Chart 8. Services remain robust, but industry and real estate have dragged down our China Activity indicator
Source: Haver, abrdn, June 2023
Unlike other countries, Chinese inflation remains muted and shows little sign of moving above target as the economy settles into endemic living. Services inflation is now running around 2% annualized &ndsash; and some more upward pressure is still likely to emerge – but there is little evidence thus far of a substantial move higher in underlying inflation that would necessitate a tighter policy stance. Indeed, given the weakness in inflation prints so far this year – combined with helpful base effects from energy and food – we are forecasting only a 1% annual increase in the headline CPI index over 2023.
Policy makers continue to strike a supportive tone, reiterating that “internal dynamism is not strong, and demand is still insufficient”. And modest additional easing has become more likely given the apparent soft start to Q2, but substantial easing still seems unlikely. Indeed, our China Financial Conditions Index shifted close to neutral in the latest update, suggesting policy is still gaining traction. Strong Q1 credit flows and the turnaround in the credit impulse should also boost activity with a lag.
The economy continues to show resilience on the back of a strong services sector and a tentative rebound in manufacturing. That said, tight monetary conditions are weighing on credit growth and soft external demand has capped hiring and new orders. Low-income households have also struggled through higher inflation and the slow recovery in employment prospects, implying a drag on demand going forward. All this means India will likely grow around trend through most of 2023, before the US recession forces the economy into a slowdown in 2024.
Headline inflation will continue to remain within the 4% +/- 2 percentage point target range through the rest of 2023 as energy price base effects feed through. Core inflation has also been easing from its highs, given reduced core goods and transportation costs (see Chart 9). However, stickiness within core services and signs of broader wage growth imply underlying inflationary pressure remains. This means Indian inflation is susceptible to spiking higher, particularly via food prices, given unfavorable weather conditions. Ultimately, underlying inflation will not recede until the economy faces a more meaningful slowdown at the turn of the year.
Chart 9. Easing inflation gives RBI scope to hold
Source: Haver, abrdn, June 2023
We expect the Reserve Bank of India (RBI) to leave its policy rate at 6.5% through the rest of 2023. Declining headline inflation and easing balance of payments pressures will allow the RBI to remain on hold and observe the effects of its hiking cycle. That said, additional tightening by DM central banks, sticky core inflation and the lagged effect of its prior hikes will give the RBI a hawkish tilt even as the economy slows in late-2023. We expect the RBI to only begin easing once a pan-EM cutting cycle gets underway in early 2024.
Growth rebounded in early 2023, driven by strength in the services and agriculture sectors (see Chart 10). We expect the former to be the primary driver of growth, and economic activity to be capped by weakness in the manufacturing sector. A boost to consumption will come via President Lula's social welfare spending. However, we expect tight monetary conditions will be enough to weaken domestic activity and cause the labor market to cool later in the year. Ultimately, the US recession will tip the economy into contraction in 2024.
Chart 10. Services sector keeping economy in expansion
Note: GVA adjustment based off 2022 data. Source: Haver, abrdn, June 2023
Headline inflation has continued to fall in recent months as base effects from energy and food have fed through. As such inflation should fall closer to target by mid- year and average 5.4% over the course of 2023. However, core inflation is receding much more gradually and remains a policy challenge (6.9% year over year in April). Indexation and the demand-side boost from Lula's fiscal stimulus will mean underlying price pressures don’t fall as sharply as the tight credit conditions would suggest. However, as the recession unfolds, core should fall more decisively heading into 2024.
The Brazilian Central Bank (BCB) will remain on hold in the near term, despite headline inflation easing. Concerns over Lula's fiscal policies and underlying inflation have limited the BCB’s appetite to begin signaling a pivot. However, we expect the lagged effects of tight credit conditions to feed through in 2023 and inflation expectations to recede. The softening in the labor market and signs that fiscal policies won’t be as profligate as feared, should give the BCB scope to cut modestly before the end of the year. As the economy contracts in 2024, we expect more substantial easing, bringing the policy rate down to 6.5%.
Table 1. abrdn Research Institute global economic forecasts
Source: abrdn (June 2023)
Figure 1. Global activity and price level in alternative scenarios, relative to baseline, two years ahead
Source: abrdn (June 2023)
Any data contained herein which is attributed to a third party (“Third Party Data”) is the property of (a) third party supplier(s) (the “Owner”) and is licensed for use by abrdn**. Third Party Data may not be copied or distributed. Third Party Data is provided “as is” and is not warranted to be accurate, complete or timely. To the extent permitted by applicable law, none of the Owner, abrdn** or any other third party (including any third party involved in providing and/or compiling Third Party Data) shall have any liability for Third Party Data or for any use made of Third Party Data. Neither the Owner nor any other third party sponsors, endorses or promotes any fund or product to which Third Party Data relates. **abrdn means the relevant member of abrdn group, being abrdn plc together with its subsidiaries, subsidiary undertakings and associated companies (whether direct or indirect) from time to time.
The information contained herein is intended to be of general interest only and does not constitute legal or tax advice. abrdn does not warrant the accuracy, adequacy or completeness of the information and materials contained in this document and expressly disclaims liability for errors or omissions in such information and materials. abrdn reserves the right to make changes and corrections to its opinions expressed in this document at any time, without notice.
Some of the information in this document may contain projections or other forward-looking statements regarding future events or future financial performance of countries, markets or companies. These statements are only predictions and actual events or results may differ materially. The reader must make his/her own assessment of the relevance, accuracy and adequacy of the information contained in this document, and make such independent investigations as he/she may consider necessary or appropriate for the purpose of such assessment.,/small>
Any opinion or estimate contained in this document is made on a general basis and is not to be relied on by the reader as advice. Neither abrdn nor any of its agents have given any consideration to nor have they made any investigation of the investment objectives, financial situation or particular need of the reader, any specific person or group of persons. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of the reader, any person or group of persons acting on any information, opinion or estimate contained in this document.
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
This communication constitutes marketing, and is available in the following countries/regions and issued by the respective abrdn group members detailed below. abrdn group comprises abrdn plc and its subsidiaries:
In the United States, abrdn is the marketing name for the following affiliated, registered investment advisers: abrdn Inc., abrdn Investments Limited, abrdn Australia Limited, abrdn Asia Limited, Aberdeen Capital Management, LLC, abrdn ETFs Advisors LLC and abrdn Alternative Funds Limited.
abrdn is the registered marketing name in Canada for the following entities: abrdn Canada Limited, abrdn Investments Luxembourg S.A., abrdn Private Equity (Europe) Limited, abrdn Capital Partners LLP, abrdn Investment Management Limited, abrdn Alternative Funds Limited, and Aberdeen Capital Management LLC. abrdn Canada Limited is registered as a Portfolio Manager and Exempt Market Dealer in all provinces and territories of Canada as well as an Investment Fund Manager in the provinces of Ontario, Quebec, and Newfoundland and Labrador.