IMF warns of “hard landing” for global economy if inflation persists

The IMF has warned of a “hard landing” for the global economy if persistently troublesome inflation keeps interest rates higher for longer and exacerbates financial risks.

Although the fund left its overall economic forecasts largely unchanged from January in its latest World Economic Outlook, published on Tuesday, it stressed that signs of resilience along with lower global energy and food prices masked a darker reality.

Pierre-Olivier Gourinchas, the IMF’s chief economist, said: “Beneath the surface . . . the turbulence is building, and the situation is quite fragile.”[ads1];

“Inflation is much stickier than expected even a few months ago,” he said. “More worrying is that the sharp [monetary] The tightening of policy over the past 12 months is starting to have serious side effects for the financial sector.”

In its full twice-yearly forecasts published on Tuesday, the IMF said the turmoil in the UK government bond market last autumn and the US banking turmoil last month showed the “significant vulnerabilities [that] exists both among banks and non-bank financial institutions”.

“Risks to the outlook are heavily skewed to the downside, with the chances of a hard landing having increased sharply,” the IMF said.

Gourinchas told the Financial Times that although the banking system was far more resilient than during the 2008 financial crisis, policymakers “had to think about what could go wrong”.

“We can all remember the long time between the failure of an individual institution, whether it was Bear Stearns or Countrywide,” he said, referring to institutions that failed more than a decade ago. “Each time this was treated as an isolated incident, until it wasn’t.”

The IMF’s new forecasts showed a 25 percent chance that the annual global growth rate could fall below 2 percent in 2023, a risk twice as great as normal. The global economy has only grown this slowly in five calendar years since 1970.

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If a significant economic shock hit – something the IMF attached a 15 percent risk to – the fund said global growth would likely fall short of population growth and result in a global recession.

In the IMF’s unchanged central forecast, the world economy is expected to grow 2.8 percent in 2023, increase to 3 percent in 2024 and stay at about that level until around 2028.

IMF Managing Director Kristalina Georgieva said last week that this was the weakest medium-term outlook for the world economy since 1990.

Gourinchas told the FT that the fund is forecasting “supercharged” growth in China, while other countries are returning to a more normal rate. The IMF also assumes global productivity will weaken as economies suffer from coronavirus pandemic “scarring” and fragmentation amid geopolitical tensions.

A chart of annual GDP growth forecasts in 2023 for the world, G7 countries, India and China showing that IMF forecasts are little changed from January, with the world at around 3%, the UK below zero and India around 6%

The US economic forecast has been raised compared to the January forecast, and the fund now expects growth of 1.6 percent in 2023 and 1.1 percent in 2024. Three months ago, the IMF suggested an increase of 1.4 percent this year followed by of a 1 percent expansion the following year.

The euro zone is expected to grow more slowly by 0.8 percent this year as member states deal with last year’s energy price increases before recovering to 1.4 percent in 2024.

China’s forecast of 5.2 percent in 2023 from the IMF is in line with the Beijing government’s target, although the fund expects it to slow to 4.5 percent in 2024.

The IMF urged central banks to continue working to bring down inflation and for governments to help by removing some of the fiscal support offered in recent years to deal with Covid-19 and the energy crisis.

As long as financial markets remained relatively stable, central banks should do everything they can to beat inflation, the fund said. Gourinchas warned that price pressures could continue to prove more persistent, resulting in a “harder landing scenario”.

“There is a concern out there that we may not have enough tightening in the system at this point and more will be needed,” he said. “It will certainly increase the chances that production will decline further compared to our projections.”

However, a credit crunch, as some economists predict in the wake of last month’s US banking crisis, could act as a disinflationary force, he said.

“As long as it’s orderly, some of this lending contraction could actually be beneficial in bringing down inflation and could replace further rate hikes.”

Janet Yellen, the US Treasury secretary, was more optimistic about the outlook, trying to ease fears of a “hard landing”.

She said she had not seen “evidence at this stage to suggest a credit crunch” following the banking sector turmoil, noting that the US economy was still “performing exceptionally well”, with “still solid job creation, inflation gradually moving down [and] robust consumer spending”.

“I would not overstate the negativism about the global economy,” Yellen told reporters. “I think the outlook is reasonably bright.”

Additional reporting by James Politi

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