MFN - IMF: Inflation peaking amid low growth

The International Monetary Fund (IMF) recently released the January update of its World Economic Outlook (WEO).¹ The outlook for growth in 2023 has improved relative to the October WEO. In this Macro Flash Note, Sam Jochim summarises the changes.

For 2023, the IMF is forecasting global economic growth of 2.9% (see Table 1), an increase from the 2.7% forecast made in October.² Despite this, global growth is still projected to decline in 2023 relative to 2022. Similar to the October WEO, the headline number hides discrepancies across different economies, with advanced economies’ growth projected to decelerate from 2022 to 2023 and emerging market and developing economies’ growth forecast to accelerate.

Source: IMF. Data as at January 2023.

In advanced economies, growth is projected to decline from 2.7% in 2022 to 1.2% in 2023 before rising to 1.4% in 2024. The upgrade to growth projections in 2023 relative to the October WEO reflects carryover effects from domestic demand resilience in 2022, lower wholesale energy prices, and fiscal support. The UK is the outlier to this, with the IMF downgrading its 2023 growth projection due to tighter fiscal and monetary policies and financial conditions and stubbornly high energy retail prices weighing on household budgets.

For emerging market and developing economies, growth is forecast to increase from 3.9% in 2022 to 4.0% in 2023 and 4.2% in 2024. Unlike in advanced economies, growth is expected to have bottomed out in 2022, though this hides discrepancies as around half of emerging market and developing economies are projected to have lower output in 2023 than 2022. The upgrade to the growth projection for 2023 is largely a result of the rebound expected in China following the move away from its zero-Covid policy towards the end of 2022.

The IMF noted that risks to the global outlook remain tilted to the downside, though they have moderated since October. January’s WEO update contains six downside risks, three of which are repeated from the October WEO.^{3, 4} The only notable change to these risks refers to the persistence of inflation in 2023. The IMF noted new factors such as labour market tightness and China’s rebounding growth as having the potential to cause inflation to remain higher for longer than expected, negatively impacting growth.

Countering this inflationary risk is the IMF’s view that China’s recovery could stall due to significant health consequences arising from low population immunity levels and insufficient hospital capacity, particularly outside urban areas. A deepening of the real estate crisis also remains a source of vulnerability according to the IMF.

An escalation of the war in Ukraine is another source of downside risk in the WEO update, particularly for Europe and lower-income countries. European gas storage was more than sufficient for the 2022 winter period and gas prices have declined further than the IMF previously expected. There is no guarantee that this will be the case in 2023, particularly if it is a cold winter. Food prices could also spike because of escalation, detracting from economic growth.

The final addition to the downside risks since the October WEO is a sudden financial market repricing. The IMF noted that a premature easing in financial conditions reflecting lower inflation data could work against monetary policies and require additional tightening. Upside surprises to inflation data could result in repricing of assets and increase volatility in financial markets, placing stress on liquidity with spill over effects on the real economy.

A notable difference from the October WEO was also the inclusion of some upside risks. The stock of excess private savings from the fiscal support provided to households during the pandemic, combined with tight labour markets and strong wage growth mean that pent-up demand is one of the IMF’s upside risks to the outlook. The WEO update points out that stock of excess savings is still growing in some economies, such as the eurozone and UK, leaving scope to boost consumption, particularly of services. The downside to this risk is that it could provide upward pressure to core inflation, leading to tighter than expected monetary policy and a stronger slowdown following this.

The other upside risk to global growth, in the view of the IMF, is faster disinflation. An easing in labour market pressures in some advanced economies could see wage inflation cool without increasing unemployment. This could reduce the amount of monetary tightening required and boost growth.

In summary, the latest IMF economic projections portray a slightly better outlook for global growth, though a slowdown is still expected, driven by a deceleration in activity in advanced economies. The IMF highlights the emergence of some upside risks to the outlook, but the balance remains negatively tilted with additional downside risks having developed since the October WEO.

¹ https://www.imf.org/en/Publications/WEO/Issues/2023/01/31/world-economic-outlook-update-january-2023

² https://www.imf.org/en/Publicatioins/WEO/Issues/2022/10/11/world-economic-outlook-october-2022

³ See EFGAM Macro Flash Note, IMF: countering the cost of living crisis (October 2022)

⁴ The remaining downside risks from the October WEO include debt distress, inflation persisting and geopolitical fragmentation.

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