Economic Growth Around The World Is A Bad News For Central Bankers

The battle to lower high inflation is becoming more difficult as unexpected economic indicators emerge from China, Europe, and the United States.

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Despite rising borrowing costs and high energy and food prices, the global economy is showing strength this week, according to business surveys. This suggests that central banks may take longer than expected to get inflation under control.

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Since the beginning of 2023, data from the U.S., China, and Europe have revealed unexpected strength in these nations' economies, defying projections from the World Bank and other analysts that the global economy was about to enter one of its weakest years in recent memory.

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While this is encouraging for governments, that resiliency may convince central bankers that they need to hike key interest rates more than anticipated in order to lower prices—effectively dumping more ice water on an economy that is still a bit too hot. This might result in slower growth later on in the year and in 2024, which was anticipated to be a year of recovery.

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The job market is a crucial metric for central banks and it's still tight in many regions of the world. Policymakers have been closely examining labor market data for indications of rising unemployment, a decline in hours worked, or a slowdown in wage increases—all of which, though elusive, may assist reduce demand and relieve upward pricing pressure.

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We have witnessed rate increases by central banks, according to Moody's Investors Service economist Madhavi Bokil. "It is hoped that a couple more rate increases will be sufficient. We might witness future rate increases if it isn't.

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The most recent indications that growth has been greater than anticipated at the beginning of the year come from S&P Global's most current factory surveys conducted globally.

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They revealed the first increase in manufacturing output globally in seven months in February, helped by a surge in China after officials removed tough Covid restrictions. The results of comparable polls of service providers conducted worldwide indicate that growth is accelerating, notably in China and Europe.

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Moreover, inflation is proving to be stickier than anticipated.

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According to the Commerce Department, inflation in the United States increased in January as consumer expenditure and income rose. The personal consumption expenditures price index, the Fed's favored inflation indicator, up 5.4% in January from a year earlier, while spending by US consumers increased 1.8% seasonally adjusted in January from December, the highest gain in over two years. More than twice as quickly as the previous month, wages and salaries increased by 0.9% in January.

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Europe has also had a strong start to the year and doesn't appear likely to experience the recession that many predicted would occur when energy prices spiked in the months after Russia's invasion of Ukraine. The price of that health: According to data released on Thursday, the core rate of inflation, which excludes food and fuel, reached a record high.

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The recovery of China has boosted industry output throughout Asia. Yet, economists are wary, in part because it is unclear how much and when the rest of the region would profit from China's liberalization.

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According to Trinh Nguyen, senior economist at Natixis in Hong Kong, the abandonment of severe economic limits in China will largely favor consumption and may be advantageous for nations like Thailand that are popular with Chinese tourists.

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But, there are still few flights leaving China, and it probably won't be until the second half of this year that the positive effects of Chinese tourists' spending become apparent.

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The rebound in China benefits the country and some industries, but not everyone in the rest of the region, according to Ms. Nguyen. "Not all boats are lifted by the tide."

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Also, there are concerns about how resilient growth in the United States and Europe will likely be. After all, recent standards indicate that interest rates have already increased extremely dramatically, and it may take some time before the full effects are felt.

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Carsten Brzeski, chief economist of ING Bank, explained that it simply takes months for tighter monetary policy to affect the real economy. "That will, too. Or, to put it another way, if the biggest change in monetary policy in years has no effect on the economy as a whole, we could also close all central banks.”

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The fact that interest rates only take off at a particular point could be another explanation for such unexpected resilience in the face of what appear to be aggressive central bank actions.

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Rates may "need to climb above a threshold such as 2% before they start to have any influence at all," according to Mark Dowding, chief investment officer at RBC BlueBay Asset Management.

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If so, "then we could suggest that the U.S. hiking cycle just actually started six months ago and that it is only just getting under way in Europe," he continued.

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Due to the robustness of the US economy, the Federal Reserve may decide to lower price pressures this year by raising interest rates more than initially anticipated. The same is true for the European Central Bank: economists at Barclays increased their projection for the central bank's benchmark interest rate and now expect it to hit a record high over the coming months in response to the spike in eurozone core inflation.

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Any indication of economic strength is likely to be met with a policy response meant to put a stop to it as long as central banks are committed to bringing inflation down to their targets.

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So, although raising its growth projections for the United States and Europe on Tuesday, Moody's still predicts a slowdown this year, to 0.9% and 0.5%, respectively. 

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Further monetary policy tightening will have effects outside those areas. It is expected to affect emerging nations, some of which—notably Brazil—have seen their inflation rates drop since raising their main interest rates earlier. When the U.S. central bank hikes interest rates, emerging nations frequently experience higher borrowing costs, weaker currencies, and decreased exports.

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According to Christian Keller, chief economist at Barclays, "for central banks, the only lesson from the current acceleration in growth and inflation can be that their tightening thus far hasn't sufficed. Will the ongoing inability of economies to stabilize eventually result in postponed recessions in 2024? ”