Global economy will be mired in stagflation in 2023

Leaders across the public and private sectors are gathering for the World Economic Forum at a critical inflection point for the global economy.

For the first time since the 1970s, economies face stagflation – a challenging combination of slowing growth and lingering inflation – making for a precarious and uncertain future.

Slowing growth looks inevitable should the world’s central banks continue to further tighten monetary policies to combat inflation. This could leave many governments and institutions in emerging markets struggling to service their debt. Additionally, economic pressures could stir social unrest, placing additional pressures on policymakers to find palatable solutions.

The forecast isn’t bright. Our Research team’s aggregate global growth forecast for 2023 reaches just 1.7% – as published in the latest edition of our flagship quarterly Research publication, Global Outlook. That’s a significant slowing from the 3.2% growth the team estimated for 2022.

Our analysts assess the depth of the issue facing leaders at Davos and describe what they see as the next, interim phase of the economy.

1. Low growth looms for major economies

The US economy has been resilient but is on course to slow, driven by the lagged effects of the Fed’s tightening, which should cause household spending to flatten, business investment to decline and housing construction to fall. We expect a mild three-quarter recession this year, starting in Q2, with gross domestic product expanding by just 0.6% over the year. (These figures have been revised higher since we published the Global Outlook in November.)

For the euro area, elevated inflation and still-modest growth in wages remain a serious drag on real household disposable incomes. Higher gas prices are also weighing on corporates and have led to an evaporation of the trade surplus. We expect a real GDP contraction of 0.1% for 2023.

As for China, the remarkable about-turn on COVID restrictions in December caused our Research analysts to raise their 2023 real GDP growth forecast by 100bp, to 4.8% y/y. But their growth estimate remains below market consensus (about 5%), on the basis of rapid accumulation of household debt, a fragile housing market, and a concentration of savings among the rich. We note that growth in credit was much slower than expected in December.

There are some brighter spots, notably in India and Brazil. Still, the latest Barclays Research global real GDP growth forecast of 2.2% would rank among the weakest outcomes for decades.

Fig1. Growth looks set to drop well below long-term averages in a world of synchronised monetary tightening and geopolitical discord

2. Weaker demand will curb inflation, but won’t end it

Inflation rates are expected to drop around the world in 2023, thanks in large part to weaker demand and some easing of kinks in supply chains. Nevertheless, our Research analysts think inflation will remain above central banks’ 2% targets by the end of the year.

In the US, for example, disinflationary pressures appear to be strengthening: headline CPI slipped to 6.5% y/y in December, the slowest pace since October 2021. But the high-level narrative of core goods deflation and robust core services inflation, supported by shelter, seemed to be intact. Prospects for returning inflation to the 2% target will be tied to the Fed's ability to slow labour demand and wage inflation. 

In the US and elsewhere, fading economic activity and rising unemployment will test the resolve of central banks. Real economic pain should become more apparent, suggesting that societal pressures to relax restrictive policy stances will likely increase.

3. Stagflation will forge a new balance

The stagflationary outlook is a natural consequence of the events and policy decisions of the past few years. The global economy bounced back in 2021, after being driven into a very deep but short recession through COVID-related lockdowns, while receiving massive fiscal and monetary stimulus. This created well-known supply/demand imbalances, which led to inflation in 2022 not seen for decades. It also brought an end to a decade-long 'Goldilocks' backdrop, in which policy makers could be relied upon to stimulate growth whenever needed, without any inflationary consequences. 

Now, with a synchronised surge in interest rates; with debt at record highs and unemployment rates at record lows; and with geopolitical frictions causing constraints in labour supply and manufacturing supply chains, stagflation seems the most likely outcome during this transitional period for the global economy.

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