Macro Insights Weekly: As growth slows, will inflation soften?

China, EU, and the US are facing simultaneous and yet varying types of economic slowdowns. With fiscal support waning and monetary policy tightening, there appears no respite.
Group Research, Taimur Baig, Radhika Rao01 Aug 2022
  • The recent US GDP data release has prompted us to adjust the growth forecasts for 2022 and 2023
  • We expect US real GDP growth to ease to 2% this year, and further slowing next year, to around 1ΒΌ%
  • As growth slows, so would inflation, especially the part driven by demand
  • We however worry that supply driven inflation will remain elevated through 2023
  • But perhaps the Fed can take it easy once a demand-crunch induced slowdown takes hold
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Commentary: As growth slows worldwide, will inflation soften?

For the US, it’s Fed tightening; for Europe, it’s energy insecurity stemming from the war in Ukraine; for China, it’s the continued struggle with the pandemic, the major economic areas are facing considerable headwind. The labour market is yet to suffer, but consumer and business confidence, dented particularly by high inflation, has been hurt noticeably. With no major fiscal support in the pipeline, and monetary policy likely to become less supportive, the waning consumption and investment outlook looks a tad ominous.

Granted, the US remains characterised by strong energy and labour demand, and a slowdown in the real estate market has yet to have a material impact. But perhaps the shoe is about to drop, especially since the costs of financing of mortgages, car loans, and credit card debt are going up rapidly. Consumers are running down their cash cushion, built during the pandemic, but that can only last so long. A technical rebound could be on the cards in the third quarter as inventories adjust, but overall, the US economy is heading downward. 

The latest US GDP data release, with its downbeat tone, has prompted us to adjust the growth forecasts for 2022 and 2023. We now expect real GDP growth to ease to 2% this year, followed by further slowdown next year, to around 1¼%. We are still ruling out a recession but foresee unemployment bottoming out at 3½% and then head toward 4% next year. If inflation remains sticky, and Fed funds rates go toward 4%, bringing along a crash in asset markets, the recessionary and jobs picture will turn out to be much worse, we reckon.   

Will softening of demand cause inflation to ease? It has got to, in our view. Already, the recent spate of weak economic data has had a sobering effect on prices, with pump price of petroleum in the US down about 13% over the past month. Agriculture commodity prices (especially wheat and soybean) have also eased a lot lately, reflecting weak demand and some favourable supply side developments. We remain concerned that supply side factors on food and fuel could turn adverse again, but we are confident that policy tightening will cause demand side inflation to dissipate.

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Taimur Baig, Ph.D.

Chief Economist - Global

Radhika Rao

Senior Economist – Eurozone, India, Indonesia

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