High inflation continues to weigh on global economy

As we look at what has happened to the world economy in 2022, it is clear that very little has turned out as expected.

The outlook at the beginning of this year was one of hope that the economy will continue to recover from the Covid-19 pandemic, and that fiscal and monetary policy will begin to normalize after two years of exceptional stimulus on both sides.

The war in Ukraine raised those expectations and led to an energy and commodity price shock that pushed global inflation to a decade high.

Watch: US Federal Reserve chief warns of ‘pain’ in slowing inflation

Central banks responded by raising interest rates at the highest rate in recent history – much more than expected at the start of the year – and global economic growth has slowed sharply in recent months.

However, inflation remains higher and stickier than most analysts expect in advanced economies.

Inflation in the UK and eurozone remains in double digits. In the US, it decreased to 7.7 percent in October, from a peak of 9.1 percent in June.

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High inflation is not just due to energy and food prices – service inflation is growing faster as goods inflation is slowing.

Another surprise for economists this year has been the strength of the labor market, despite high borrowing costs and slow economic growth.

Unemployment rates in the US, UK and eurozone are at their lowest levels in 30 years and labor demand continues to outstrip supply, putting upward pressure on wage growth.

To some extent, this reflects the fact that many workers who left the workforce during the pandemic have not returned to look for work even as the demand for workers remains strong.

Despite recent headlines about the demise of the US tech sector, the number of people claiming unemployment benefits for the first time has not started to rise, and monthly growth in nonfarm payrolls remains strong.

With aggregate demand seemingly resilient to higher borrowing costs so far and inflation still well above the central bank’s target, it looks like officials will continue to tighten monetary policy in the coming weeks.

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The Bank of England, the European Central Bank and the US Federal Reserve are likely to offer another 150 basis points of rate hikes when they meet in mid-December and further increases are expected in the first half of 2023.

The silver lining for borrowers is that the rate of inflation is likely to slow, barring any negative inflation shock between now and mid-December.

Fed officials have indicated that they are open to a 50 bps increase in policy rates rather than the 75 bps we have seen in the previous four meetings. The ECB and BoE are also expected to offer similar quantitative easing.

This slower pace of tightening allows more time for the full impact of inflation to reach the real economy, which can take a year or more.

However, that does not mean central banks are becoming more pessimistic about the outlook for inflation.

A few weeks ago, several Fed officials pushed back against the market’s expectations of a “pivot” in policy, saying that rates could go higher than indicated in the last set of forecasts (in September), even if they arrived slowly.

And even if the Fed is ready to pause, it’s unlikely to lower rates until inflation is well under way and has been truly kicked out of the economy.

Khatija Haque is an economist and head of research at Emirates NBD

Updated: November 21, 2022, 4:30 AM


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