The International Monetary Fund has 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.

Global economic outlook slows for 2023
The global economy faces slowing growth as the three largest economies, the US, China, and the European Union (EU), are projected to stall, according to a new analysis (October 2022) by the International Monetary Fund (IMF).  Although IMF’s global growth forecast for 2022 is unchanged at 3.2%, IMF lowered its growth forecast for 2023 to 2.7%—0.2 percentage points lower than its forecast from July (July 2022)—and now with a 25% probability that the global economic growth rate could fall below 2% in 2023. More than a third of the global economy is projected to contract this year (2022) or next (2023), including the US, the European Union, and China. “In short, the worst is yet to come, and for many people, 2023 will feel like a recession,” according to the IMF’s World Economic Outlook.

Global economic activity is experiencing a broad-based and sharper-than-expected slowdown, with inflation higher than seen in several decades. The cost-of-living crisis, tightening financial conditions in most regions, Russia’s invasion of Ukraine, and the lingering COVID-19 pandemic all weigh heavily on global economic growth, according to IMF. Global growth is forecast to slow from 6.0% in 2021 to 3.2% in 2022 to 2.7% in 2023. This is the weakest growth profile since 2001 except for the global financial crisis of 2008/2009 and the acute phase of the COVID-19 pandemic, according to the IMF analysis and reflects significant slowdowns for the largest economies: a US contraction in gross domestic product (GDP) growth in the first half of 2022, a euro area contraction in the second half of 2022, and prolonged COVID-19 outbreaks and lockdowns in China with a growing property sector crisis

In the US, the tightening of monetary and financial conditions will slow growth to 1% in 2023, according to the IMF analysis. In China, IMF has lowered its growth forecast to 4.4% due to a weakening property sector and continued lockdowns due to the country’s zero-COVID policy. The economic slowdown is most pronounced in the EU, where the energy crisis caused by the war in Ukraine will continue to have a strong impact, with IMF reducing its growth forecast or the EU to 0.5% in 2023.

Despite the economic slowdown, inflation pressures are proving broader and more persistent than anticipated. Global inflation is expected to peak at 9.5% this year (2022) with an overall annualized inflation rate of 8.8% in 2022 before decelerating to 6.5% in 2023 and to 4.1% by 2024. Global core inflation rose from an annualized monthly rate of 4.2% at the end of 2021 to 6.7% in July (July 2022) based on a median country analysis.

Further downside risks
The IMF also points to further downside risks to the global economic outlook. First is the risk of monetary, fiscal, or financial policy miscalibrations. The IMF says that global financial conditions could further deteriorate, which in turn would create more volatility in financial markets and push investors toward safer assets, such as US Treasuries, and push the US dollar even higher. Additionally, inflationary pressures could prove to more persistent, especially if labor markets remain extremely tight. Finally, the outcome of the war in Ukraine is still uncertain and its status could continue to exacerbate the energy crisis.

In taking into account these risk around its baseline projections., the IMF estimates that there is about a one in four probability that global growth in 2023 could fall below the historically low level of 2% . If many of the aforementioned risks materialize, global growth would decline to 1.1% with quasi stagnant income-per-capita in 2023, according to the IMF analysis. According to its calculations, the IMF projects that the likelihood of such an adverse outcome, or worse, is 10% to 15%.  

Inflationary pressures, monetary policy impacts
The IMF analysis says that increasing price pressures remain the most immediate threat to the current and future growth prospects by squeezing real incomes and undermining macroeconomic stability. Central banks are focused on restoring price stability, and the pace of tightening monetary policy has accelerated sharply.

IMF points out that the risks of both under- and over-tightening monetary policy exists. “Under-tightening would further entrench inflation, erode the credibility of central banks, and de-anchor inflation expectations. As history teaches us, this would only increase the eventual cost of bringing inflation under control,” according to the IMF analysis. “Over-tightening risks pushing the global economy into an unnecessarily severe recession. Financial markets may also struggle with overly rapid tightening.”

In addition, the US dollar is now at its strongest since the early 2000s although the appreciation is most pronounced against currencies of advanced economies. So far, the rise appears mostly driven by fundamental forces such as tightening US monetary policy and the energy crisis.