Alan McQuaid is a leading economist and media commentator. He has previously worked with the Department of Finance and several Irish firms including both Merrion Stockbrokers and Cantor Fitzgerald Ireland.
Just when it appeared that the world economy was recovering from the pandemic, the cost-of-living crisis and the aggressive increase in interest rates by global central banks in response, threatens to push it back into recession. There are several problems facing the world economy. In Europe we have an energy crisis that could potentially exceed the 1970s in its severity. The huge rise in electricity/gas bills is set to put a major squeeze on consumers’ real incomes and companies’ profitability. Then we have the tightening of monetary policy delivered in response to the more general rise in inflation, which is starting to slow demand, with housing markets coming under particular pressure. And of course, we have the situation with China, which continues with its zero-Covid policy thereby restraining the economy and hampering other efforts to support demand. The worry is that each of these problems has no obvious or easy policy solution. Europe’s energy crisis is a negative supply shock.
Policymakers can aim to redistribute the costs between members of society or try to push them out into the future, as they did during the pandemic. But high and still rising inflation rates now make that latter option more difficult to deliver. The fiscal response required to shield the private sector might simply encourage European central banks like the ECB and Bank of England to hike rates even further. Other central banks around the globe face a similar, though less acute, challenge. The bottom line is that they’ve underestimated the surge in inflation over the last 18 months or so and are unwilling to take any more risks. In their view, bringing inflation back down to more acceptable levels is a prerequisite for supporting the economy in the future. They appear willing to tolerate a recession to achieve that aim. As things currently stand, the Fed, the ECB, and the Bank of England all look likely to deliver further sizable hikes between now and year-end, leaving rates in ‘restrictive’ territory. On the face of it, China’s problems seem the easiest to resolve, but in reality, may be the hardest to fix, which in turn could extend the pain of the world economy as a whole for some time.
China in particular remains a major worry
Public health objectives – which reflect the government’s unwavering resolve to avoid mass fatalities in a nation with relatively low vaccination rates among the elderly and less effective vaccines – have long trumped economic goals. However, managing the trade-off between fighting the virus and inflicting economic harm has become exceptionally difficult, so much so that the policy response to the downturn is increasingly ineffective. China is caught in an economic trap of its own making.
US likely to fall into recession before year-end or early 2023
The US posted two successive quarters of negative GDP growth in the first half of 2022, which implies a technical recession, but bounced back in the third quarter. However, this was mainly due to a strong international trade performance with the key consumer spending component weak, which doesn’t augur well going forward. Looking at the overall picture, I think the world’s largest economy could tip into a formal recession towards the end of this year or early in 2023, with the unemployment rate heading back up towards 6% by late next year.
An electric shock in Europe
The rise in energy costs already appears to have pushed parts of Europe into recession. The German economy is contracting, while the Eurozone as a whole and the UK are barely growing. So far, the labour market has held up, with unemployment rates at record lows in Euroland and still close to 50 year lows in the UK. However, the downturn should broaden and deepen as we head into the Winter, and the jobless levels could start rising from the fourth quarter onwards, with the shock to real incomes set to be one of the largest in recent memory.
All Change In The UK
It has been quite a tumultuous and in many ways historic couple of months in the UK, with the death of Queen Elizabeth II, the region’s longest ever serving monarch, and then Liz Truss lasting just 45 days as Prime Minister, the shortest ever period in office. Rishi Sunak is now in Number 10 and he is the first British PM of Asian origin and at 42 years of age the youngest leader in over 200 years. He faces a very tough challenge to get the economy back on its feet and to restore public confidence in the Conservative Party.
Irish economy continues to perform well
Despite all the trials and tribulations across the world, the Irish economy continues to perform very well. There were record numbers employed in the second quarter and real GDP growth of 1.8% in the April-June quarter was again one of the highest in the EU. At the half-way point of the year GDP was 11% higher than in the same period last year, leaving the country on course to once more top the EU growth league table, where it has been consistently since 2014. Robust economic activity has led to a significant increase in tax revenue leading to a substantial Exchequer surplus and the scope to provide major assistance to households and businesses to combat soaring energy bills over the winter months. However, the continued strong performance of corporation taxes in the year-to-date again highlights the over dependence on the US multi-national sector. And in a lot of ways the healthy bottom line GDP numbers mask Ireland’s two-tiered economy with many of the domestic oriented sectors continuing to struggle post the pandemic while the foreign-owned companies thrive. Meanwhile, leading indicators like the purchasing managers’ indices point to a slowing down in growth in the second half of the year and even with Government supports in the Budget to combat the cost of living crisis, it is hard not to see how soaring energy bills and higher interest rates don’t impact consumer spending negatively in the coming months. After a very positive first half of 2022, I expect a more challenging second half and a tougher 2023 unless the Russia/Ukraine conflict is resolved. As things currently stand, I expect lower economic growth and a higher unemployment rate next year than we had in 2022 but still a better performance than the majority of our EU peers.
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