People are worrying about a global recession and with good reason. But what if the factors driving rising prices are beyond the limits of policymakers’ control?
The squeeze on living standards
We haven’t seen a squeeze on living standards like this for some time. Real incomes are falling in a way they haven’t done since the second half of the 1970s, when inflation was very high, or the early eighties, when we had a really big oil shock.
In the 1970s, meat prices rose 25% in one year alone and milk and dairy prices shot up almost 22%. Driven by war, loose monetary policy and energy supply problems, inflation in the 1970s topped out at 22%.
At the moment an oil shock is playing a part in the squeeze on incomes: energy prices in most parts of the world are up more than 40%. But it’s broader than that, because we’re also seeing food prices rise – these are inflating at high-single and low double-digit numbers. On top of this, we’re also seeing a range of goods’ prices rising.
So, compared to our recent history, when inflation’s been around one-and-a-half to two percent, that’s quite a big pickup. Households are feeling that squeeze across the board.
If it feels like things are bad, it’s because they are
The “misery index”, an economic indicator that helps determine how the average citizen is doing economically, is now in the highest 20% of readings over almost 50 years.
We’re effectively at the early stages of an economic slowdown. When you’re looking for signs of this, you look towards the housing market. We are seeing the effect of high mortgage rates beginning to slow down the housing market.
Retailers are trying to make cuts as they go along. They’re introducing cheaper lines of products so that people can continue to spend, but they don’t have to spend quite so much.
As we go forward, with the hit to living standards, people will adjust their spending behaviour. We will likely start to see much more in the way of evidence of weaker consumer spending coming through, particularly on retail sales. This will be the second sector to drop after the housing market slows.
Can central bankers do anything?
Central bank policymakers have fallen behind the curve. There has been a lot of uncertainty and I think central bankers felt that they didn’t want to tighten too early because if they got it wrong it could really crunch the economy.
Had they reacted earlier, we might not have seen inflation or wages rise as much – and we could be looking at a more gradual slowdown. But now we’re looking at something a bit more aggressive in the way of a sharper slowdown as a result.
Central bankers have been quick to blame outside influences for the cost of living crisis, such as war in Ukraine. Is it outside central bankers’ power to ease soaring costs?
I don’t believe it is. About 80% of the consumer price index (CPI) is not oil or food. What a central bank should be doing is targeting the rest of the basket that isn’t food or oil, and tightening policy to bring inflation down to offset rises in those two components.
What can governments do to help?
Governments can help by taking actions that might be unpopular with voters such as raising taxes, freezing income bands and tightening the purse strings, but there’s not much else beyond that. Back in the 1970s, they tried all kinds of income and pricing policies and none of them really worked. So it’s down to the central banks to do the right thing.
Are we heading for a global recession?
The probability of a global recession toward the end of this year or early next year is quite high – it’s probably in the order of 35%.
Different regions have got different risks, however. While everybody’s got a measure of inflation risk – particularly the US and Europe – China, as an example, has a big problem in the form of its zero COVID policy.
While it has had to shut down a lot of the economy in order to implement that policy, our assumption is that China can emerge from that later on this year. Authorities have succeeded in bringing COVID under control, but they are still putting numerous measures in place so there is still quite a way to go. In the meantime, economic activity is very weak and China is not currently contributing much to global growth.
In Europe, alongside how to bring inflation under control, is the question of what to do about Russian energy. A partial oil embargo has been agreed and this will put a lot of pressure on European industry and households as parts of Europe are very dependent on Russian energy. Germany and Italy, for example, get a quarter of their energy from Russia. So, an embargo could cause quite a sharp slowdown in economic activity.
Are investors starting to price in a recession?
Not yet, although they have started to think pretty seriously about it. This is why we have seen weakness in equities and parts of the credit markets.
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