Can we avoid a global recession in 2023?

The bad news is that the US, euro area and UK economies are (at best) expected to suffer a period of economic stagnation this year. But all this gloom is overshadowing some happier news: according to most forecasts, we will avoid a global recession this year. Despite a stagnant outlook for most advanced economies, analysts expect the world economy to grow somewhere between 1 and 3 per cent in 2023 (see chart). 

Global recessions are relatively rare – but acutely unpleasant. Since the Second World War, the world economy has endured only five global recessions – in 1975, 1982, 1991, 2009 and 2020. The most recent was dubbed ‘The Great Lockdown’ by the IMF, and represented the worst global contraction since the Great Depression. 

A global recession is loosely defined as an annual contraction in world real gross domestic product (GDP) per capita, accompanied by a decline in measures of economic activity such as industrial production, oil consumption and trade. This rather messy definition arises due to the difficulty of relying on GDP figures alone: fluctuations in large economies can ‘offset’ each other (the Indian economy could grow as the euro area contracts, for example), while waiting for annual data can mean that important trends are missed. 

Worse than the sum of its parts

Crucially, a global recession does not mean every country in the world enters recession at the same time. During the global recession that followed the financial crisis, China and India still registered positive growth as other major economies contracted. And it follows that some economies are more sensitive to global slowdowns than others. Research from the National Bureau of Economic Research (NBER) found that a German downturn following the financial crisis would have been inevitable – even in the absence of domestic shocks – because of its strong trading relationships with the rest of the world. 

Thanks to unpleasant spillover effects, the impact of a global recession can be greater than the sum of its parts. As economies around the world contract simultaneously, financial conditions tighten, business confidence declines and policy uncertainty increases. Although it might seem like cold comfort as the UK economy stagnates, dodging a global recession would be welcome news. 

Reasons for optimism in 2023 

There are several reasons for optimism this year. Firstly, even if major economies do tip into contraction territory, the downturns are unlikely to be severe enough to drag the world economy into a true global recession. Take the UK: Bank of England forecasts now suggest a milder and shorter UK contraction, while according to the National Institute of Economic and Social Research (NIESR) think tank, the UK may avoid a ‘technical recession’ entirely in 2023. 

What’s more, a series of more dovish policy announcements from central banks this month suggested that lower inflation could pave the way for interest rate cuts and higher growth in the year ahead. Sara Johnson, executive director of economic research at S&P Global Market Intelligence, expects global growth to pick up to 3 per cent in 2024 as interest rates retreat. 

In the meantime, today’s higher interest rates are at least operating against a more favourable backdrop. Bruce Kasman, head of economic and policy research at JP Morgan, said that “the financial conditions drag is being cushioned by a fading of supply chain and commodity price shocks”. 

Economists are also hopeful that the global economy is starting to recover from the shocks that hamstrung 2022. Deutsche Bank’s Jim Reid argues that the global economy could finally be “normalising” from the impact of the Ukraine war and China’s zero covid policy, and (more on this in my column next week) China’s reopening could deliver a significant boost to global demand this year. 

Growth could still be derailed this year

But the global economic position remains precarious. Economists at the Conference Board think tank warn that one extreme event or a combination of several smaller unfavourable events could “thrust the world back into recession”. A deeper than expected slowdown in the US, China or Europe, an escalation of the war in Ukraine or worsening energy shortages could all derail fragile growth.

And though global growth forecasts look promising, they are fallible. As the second chart shows, the International Monetary Fund (IMF) revised its growth forecasts substantially between October 2022 and January 2023 (although the UK was the only economy to see a substantial downgrade). Research conducted by the Financial Times in 2018 found that the IMF consistently under-predicted recessions, and the challenges of making projections (for all macroeconomic forecasters) have only intensified since the pandemic and the Russian invasion of Ukraine. 

Monetary policy matters 

Although markets are eagerly awaiting rate cuts, the end of the global tightening cycle is not here yet. There remains a risk that central banks will overtighten – and tip economies into recession as a result. Economists at AXA Investment Managers warn that monetary policy runs the risk of overshooting, and Gilles Moec, group chief economist, thinks that an interest-rate-induced recession may be the price we have to pay to get inflation back under control.

Increased borrowing costs could also start to threaten macroeconomic stability. JP Morgan analysts argue that problems with low-income commodity importers, UK pension funds and the crypto sector might look unrelated, but are all a symptom of the kind of stress that rapidly tightening financial conditions can trigger. Yet cutting interest rates too soon could also be bad for growth. Economists at the World Economics Forum argued in January that excessive tightening could be the ‘lesser of two evils’, warning that central banks risked “potentially even steeper monetary tightening at a later date to restore price stability” if they give up the fight against inflation prematurely. 

Marko Kolanovic, chief global markets strategist at JP Morgan, expects global central banks to ‘pivot’ later this year, leading to rate cuts. On the plus side, he thinks that this would lead to a sustained recovery of asset prices by the end of 2023. But for this to happen, the world economy may need to endure a period of economic weakness, rising unemployment, market volatility and decline in risky assets as inflation comes under control. He says that “all of these are likely to cause or coincide with downside risk in the near term”. 

This backdrop makes it hard to predict what central banks will do next. Analysts at CIBC Asset Management note that for the past three decades, central banks have responded to recessions by aggressively easing monetary policy, providing a “loud-and-clear lift-off signal for financial markets”. This time could be different: the spectre of high inflation means that global monetary policy might “stay in restrictive territory for longer than generally believed”. 

How a global recession would impact UK investors

Even if we technically avoid a global recession, downturns in key markets would still cause headwinds this year. John Higgins, chief markets economist at Capital Economics, thinks that if major economies enter recession in the spring, risky assets will drop back, only to recover later in the year. What’s more, news of recession could take investors by surprise: Higgins thinks that markets have priced in falling inflation and monetary policy loosening, but questions whether recessions have been “discounted” yet. The performance of the US economy could also cause widespread ripples: Higgins expects developed market equity markets to “take their directional cue from developments in the US” this year. 

Recession fears could also “sour risk sentiment”, and increase demand for the dollar as a safe haven: analysis from Capital Economics suggests that the pound could fall to $1.12 against the dollar by the middle of the year. This matters for UK investors. Twenty-three per cent of FTSE 350 revenue is generated in the US, and the US stock market accounts for around 76 per cent of the MSCI World Index. Analysts at Capital Economics forecast that the pound could recover to $1.25 as the outlook improves over the course of the year. 

Emerging markets will not escape unscathed

Analysts at CIBC Asset Management think that global bonds will offer better returns over the next 12 months, but said that investors should be “prudent and selective with emerging market (EM) bonds”. CIBC analysts said that the overall macroeconomic environment for the first half of the year will be “dicey” for riskier bond holdings and warn that a protracted global growth scare in 2023 could lead to further EM bond outflows. 

Luis Oganes, head of currencies, commodities and emerging markets (EM) research at JP Morgan, thinks that global and US economic cycles will remain the “primary drivers” for EM assets in 2023. He notes that the worst moves for EM risky assets tend to be seen in US recessions with large widening in credit spreads and lower equity prices. Despite their brighter economic prospects (see first chart), EM economies may not be able to escape the impact of stagnation elsewhere.