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Key findings
1. Global growth has so far remained relatively resilient through an extreme surge in inflation paired with one of the sharpest monetary tightening cycles in generations. This suggests that both contracting supply and expanding demand contributed to rising prices and raises a key question for the coming 12 months: have central banks really managed a soft landing of the global economy in such a complex situation? Or is the world facing a hard landing because central banks overreacted to mostly supply-driven inflation, or because they still underestimate the shift in inflation dynamics and will have to go even further to break them?
2. A soft landing is possible. Global inflation has fallen from more than 9% in 2022 to below 6%. Energy disinflation may have run its course, and food inflation is falling. Remaining pandemic-era supply disruptions have faded, suggesting consumer goods will get cheaper. Once wages have adjusted to higher prices, services inflation should also fall. In Europe – but not in the US – we expect inflation to fall below 2% in the second half of 2024.
3. Lower inflation, higher growth? Supply-driven inflation lowers growth, so as it reverses it should stabilise demand while at the same time allowing central banks to cut interest rates. This makes a soft landing more likely, particularly in some emerging markets in Asia and South America, where growth prospects have brightened and central banks are already cutting rates. But the path to a soft landing looks increasingly narrow – especially in the US and Europe.
4. Has the US battle against inflation only just begun? In the US, inflation is expected to stay above 2% beyond 2024. Wage growth is not normalising, and growth and the housing market are picking up despite high interest rates. The risk that the Fed has not yet done enough is significant. While the bar to significant further rate hikes is high, rates may have to stay high for longer to achieve the necessary cooling of growth and inflation.
5. Even in weak-growth Europe, inflation may not return to target quickly. Wage growth is set to remain high and services inflation usually moves in lockstep in both the Euro Area and the US. Wage growth would have to be absorbed by falling profit margins or by rising productivity growth. However, neither has been the norm in recent decades.
6. Despite strong wage growth and fading inflation, we expect the Euro Area economy to shrink for the next three quarters. Weak external demand, labour shortages, uncompetitive energy prices and the housing market are expected to weigh on growth before the full extent of the policy tightening has taken effect. In contrast to the US, there is a significant risk that the European Central Bank has already overtightened. If the Euro Area falls into a protracted recession, and deflationary tendencies return, the ECB would need to react quickly and decisively to avoid returning to the effective lower bound.
7. Global recession? Excluding China, we are now forecasting world GDP growth of less than 1% in 2024, fulfilling some definitions of a global recession. And for China we are not optimistic either. China’s economy is struggling to gain momentum as the global manufacturing cycle weighs and structural weaknesses such as demographics and high debt combine with hesitant stimulus.
8. Global interest rates are most likely to fall. Rate hike cycles are coming to an end at 4% in the Euro Area, just over 5% in the UK and just under 6% in the US. Weak growth makes rate cuts most likely from Q2 2024, especially in Europe. In the US, the risks are skewed towards higher rates for longer, however.
1.1 Introduction Even though global inflation rates have come down significantly since 2022, the fight against inflation continues to dominate the global economic policy agenda. At the time of the 2022 Green Budget, in October 2022, world inflation peaked at 9.3% year-on-year, more than three times higher than the pre-pandemic norm of around 3% (see Figure 1.1). By June 2023, it had fallen halfway back to the norm, and stood at just under 6%. Both the rise and decline were fairly uniform across advanced economies and emerging markets. In the former, inflation peaked in October 2022 at 8% and fell to just over 4% in June, 2 percentage points (ppt) above ‘normal’. In emerging economies, inflation peaked at 11.3% in September 2022 and was by June back down to just under 8%, 4ppt above the norm of 4%. Even outliers such as Turkey have seen year-on-year inflation halve, from 80% to 40% over the same period. Figure 1.1. World composite inflation (year-on-year %)
Source: Haver Analytics and Citi Research.
As we highlighted in chapter 1 of last year’s Green Budget, the major drivers of the inflation surge – and subsequent reversal – were widespread supply-side factors, such as pandemic-era supply chain disruptions, labour force distortions, and more recently the repercussions of Russia’s invasion of Ukraine for energy and food prices. This explains the strong global co-movement of inflation rates. Less clear is the role of demand. During the pandemic, many governments generously maintained or even increased corporate and household incomes, for example by sending out checks (US) or allowing employers to put employees on furlough (Europe), funded by aggressive government borrowing. This was facilitated by unprecedented central bank easing, especially asset purchases, and did not just allow households in some parts of the world to maintain large parts of spending (Europe) or even increase it (US) during the pandemic, but also to save large amounts and maintain spending beyond the end of the pandemic.
The high inflation rates caused by this combination of a series of large negative supply shocks and positive demand shocks risked becoming so persistent that they would dislodge inflation expectations and thus perpetuate high inflation. Central banks therefore stepped in to anchor expectations, break the inflation surge and swiftly return inflation to target. With inflation rates now well into their decline in most parts of the world, we and most forecasters see global central bank interest rates close to the peak or even starting to reverse.
Global growth has remained resilient through the extreme surge in inflation paired with one of the sharpest monetary tightening cycles in generations, which suggests that both supply and demand contributed to rising prices. That raises the key question for the coming 12 months: have central banks really managed a soft landing of the global economy in such a complex situation? Or is the world facing a hard landing because central banks overreacted to mostly supply-driven inflation, and exaggerated concerns that monetary policymakers could lose credibility and inflation expectations could rise? Or do central banks still underestimate the shift in inflation dynamics, and will they therefore have to tighten even further to break them?
We begin in Section 1.2 by discussing how the easing of supply constraints, and the resilience of demand, point to a possible ‘soft landing’. We then consider, in Section 1.3, the trends in the labour market and elsewhere which point to the risk of inflation (and interest rates) staying higher for longer. In Section 1.4, we consider the possibility that central banks have already gone too far. In Section 1.5, we examine how the outlook varies across regions, before finally presenting Citi’s latest forecasts (Section 1.6) and concluding (Section 1.7).
1.2 Can we manage a soft landing?
Over the past three years, the world experienced a series of highly unusual supply disruptions and thus cost shocks.
Pandemic-induced supply shocks First were the shocks triggered by the public health policy reaction to the pandemic, which largely affected goods inflation and have largely faded by now:
The global shipping market has relaxed, with key freight cost indices well down on post-pandemic peaks and in some cases below pre-pandemic levels. The Baltic Dry Index, which measures daily rates of dry bulk carrier ships, is averaging 1142 so far this year, down 75% from the 2022 peak and actually 15% below the 2018–19 average. The Harper Petersen Index, which measures weekly container vessel spot chart rates, has averaged 1156 so far this year, which is still double the pre-pandemic average, but also down 75% from the 2022 peak, despite issues around the Panama Canal, for example
Supplier lead times are shortening substantially. In the US Institute for Supply Management (ISM) manufacturing index, for example, supplier lead times were lengthening at their strongest pace since the 1970s in 2021, but are now shortening at the fastest rate since the global financial crisis in 2009.
Where inventories of finished goods were depleted in 2021, now firms are reporting that they have too much in stock. In Germany’s widely followed ifo manufacturing survey, for example, firms are now reporting inventories nearly as full relative to demand as they were during the first lockdown in 2020. In summary, the Federal Reserve Bank of New York’s Global Supply Chain Pressure Index has dropped from more than four standard deviations above its post-1997 average in late 2021 to a trough of one-and-a-half standard deviations below it this year (Figure 1.2). This has triggered a disinflation process in core goods, though one which is far from complete (also shown in Figure 1.2). Figure 1.2. Global supply chain pressures (standard deviation from mean) and advanced economy core goods CPI inflation (year-on-year %)
Note: AE = advanced economy and represents a weighted average of US, Euro Area, Japan and UK non-energy industrial goods inflation. Source: New York Fed, Haver Analytics and Citi Research.
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