The world economy has performed better this year than generally anticipated at the beginning of 2023, though the upturn has been modest and significant downside risks remain. The fall in energy prices in the first half of the year has clearly helped to lower headline inflation rates across the globe, thereby easing the pressure on consumers to some degree. The outlook has also been helped by the faster than expected re-opening of the Chinese economy following the prolonged Covid lockdown. However, the recovery in the world’s second largest economy has not been as strong as many thought, with some recent signs of a slowdown, which if sustained, could weaken economic growth in China’s trading partners worldwide and negatively impact global business confidence.
But the key concern is that core inflation, which excludes volatile food and energy prices remains sticky and the impact of tighter monetary policy is more and more being felt around the world. And if core inflation stays elevated for longer than anticipated, then it is likely that more interest rate hikes will be needed down the line to bring price pressures under control, resulting in a further hit to already stretched household budgets.
One of the main problems for central bankers is that the strength of the impact from the rate increases so far is hard to judge, especially after an extended period of very easy policy and the speed at which official interest rates have subsequently been increased. And of course another worry for the global economy is the ongoing conflict between Russia and Ukraine, which could easily at any point again disrupt global food and energy markets, while the latest atrocities in Israel/Palestine will only add to geopolitical tensions across the world. Still, despite all the uncertainties, it now looks as though the global economy will see a “soft landing” rather than an outright recession which many had predicted.
Headline inflation rates around most of the world have decreased in recent months due in the main to the drop in energy prices, even though food product and services prices have continued to rise sharply. All in all, it appears that headline Inflation has peaked for now, and many in the financial markets expect it to fall back towards 2% over the next year or two and remain there even allowing for the recent rebound in oil prices. However, I am not so sure. Further declines look possible in the short-term but the medium-term outlook is more difficult to gauge. Indeed there is every chance that the world economy could be facing into more frequent inflation shocks, coming from a number of sources, including climate change and US-China tensions. Over the last year-and-a-half, underlying inflation has consistently proved to be higher than projected. At the end of the day, the large shocks that have impacted the global economy and the range of factors contributing to higher inflation, both on the demand and the supply side, make it hard to assess the speed at which inflationary pressures may recede on a sustained basis.
Stubbornly high inflation has seen a dramatic response from the world’s main central banks. The Federal Reserve has already raised US interest rates 11 times in the last 18 months, most recently in July. That’s the most aggressive series of rate hikes since the early 1980s, and leaves the Fed’s benchmark borrowing cost between 5.25% and 5.50%. Clearly, a lot will depend on what happens on the data front in the coming months but a rate cut looks a long way off at this stage. Meanwhile, over in Europe the ECB has pushed its key interest rates to the highest levels since the adoption of the euro back in 1999 and the Bank of England has raised its key lending rate 14 times in this tightening cycle to 5.25%. Central bankers face difficult decisions but the reality is that monetary policy will need to remain restrictive until there is clear evidence that underlying inflationary pressures are under control. This may result in additional rate increases in economies in which high core inflation proves persistent. The worry then is that significant additional monetary tightening raises the chances of abrupt asset repricing and risk reassessments in financial markets.
As regards the Irish economy, the most recent figures from the Central Statistics Office (CSO) showed that as measured by GDP it rose by 0.5% on a quarterly basis in the April-June period. This was a positive development following two quarters of contraction (the definition of a technical recession) in national output. Meanwhile, modified domestic demand, which excludes some of the activities of the multinational sector, and thereby gives a better indication of what is happening in the domestic economy, rose by 1% in the quarter. In the second quarter there was a drop in exports across all the multinationals, implying weaker global demand, but against that, there was a strong jump in industrial output, suggesting that the multinationals may have been stockpiling in the second quarter and exports could recover later in the year. Despite the quarterly increase in both GDP and modified domestic demand in the April-June period, they were both down on an annual basis and indeed economic growth was basically flat in the first half of the year, a sign that at least temporarily, Ireland is moving to a more modest rate of national output after years of very strong expansion.
Still, it is hard to reconcile the GDP numbers with the latest labour market data, showing record employment of over 2.643 million in the second quarter and the jobless rate hovering just above 4.0%. However, the National Accounts data along with the corporate tax figures again highlight how the ups and downs of the multinational sector can distort the headline picture of the Irish economy at any given time. But, the strong labour market suggests that the domestic economy will do well in 2023 and the record numbers at work should ease the burden on households to some degree from the huge rise we’ve seen in the cost of living over the past couple of years. Furthermore, income tax relief and increases in social welfare benefits in Budget 2024 along with recent price reductions from the main domestic energy suppliers will help boost disposable incomes in the run up to Christmas and over the Winter months. Looking ahead to next year, economic growth is likely to remain low by recent historical standards as tighter monetary policy continues to bite and geopolitical risks remain high. However, the Irish labour market should continue to be strong, with the jobless rate holding between 4.0% and 4.5%.
Author: Alan McQuaid is a leading economist and media commentator in Ireland. He has worked with the Department of Finance and the leading Irish stockbroking companies.