Scope Ratings: World economy is in soft landing, inflation risk continues

Scope Ratings has published its mid-year global economic outlook report. The prominent paragraphs from the report, which draws a very optimistic outlook for 2024-2025, are as follows:

The growth observed in 2024 was consistent with Scope Ratings’ long-standing assumption that the global economy would enter a soft landing, even after the fastest interest rate increase in contemporary history. It seems unlikely that central banks will return to the very low interest rates they had before the pandemic, due to shock-resistant and strong economic activity. Higher rates for longer periods of time may be a boon for creditor segments such as financial institutions, but may pose difficulties for many other segments.

We predict that global growth will be 3.2% this year and 3.4% next year, compared to 3.2% in 2023. Our growth bets are 0.1-0.2 points above our outlook at the end of last year and well above the global growth potential of 2.6%. Economic growth has repeatedly defied consensus expectations of a recession.

Considering GDP growth in the first quarter and purchasing manager surveys, the Eurozone economy has recovered in recent months; Therefore, we are betting on 1.0% growth this year and 1.7% for 2025. This takes into account slow growth of 0.2% in Germany this year. But we believe this will rise to 1.4% next year. France and Italy are growing slightly below potential rates. Several economies affected by the previous crisis around Spain and the euro zone continue to grow at rates above euro zone averages. Outside the EU, the UK economy will grow by 0.8% this year, after 0.1% last year.

Growth in Europe remains significantly slower than growth in the US, where a strong 2.7% increase is expected in 2024; This is 0.5 points better than our consensus bets at the end of last year. Among emerging economies, China’s output will rise 5.2% this year, currently seen as being in line with the government’s annual target of 5%. Growth in Europe will be stronger next year than this year, but the opposite is possible outside Europe.

Stable Macro Risks for 2024

The upstream risks we identified regarding the global economy have become partially evident, especially with the growth that was better than expected in China, the world’s largest economy in terms of purchasing power. In our 2024 outlook, we predicted a “balanced” risk trend for the global and European economies this year. But macroeconomic risks continue. A more persistent inflation than expected could keep interest rates at current levels for a long time and/or, in a negative scenario, lead to a further tightening of monetary policy.

The economic consequences of geopolitical tensions may become unpredictably dire. Considering the high interest rate scenario for a longer period of time, financial instability may arise again. Finally, investors may overprice country risks in the face of increasing political uncertainty and financial difficulties.

For example, budget sustainability concerns in France could destabilize euro zone markets if the new parliament does not address these problems following snap elections. If inflation remains above target and some countries, such as France, violate EU fiscal rules, the capacity of Eurosystem policymakers to find a solution to the rampant market volatility may be limited.

Regarding financial stability risk, the accumulated bankruptcy risks in commercial real estate are quite significant, but are not seen as a systemic concern in the near term at this stage.

Inflation is falling but remains above target in an environment where ongoing price pressure and new shocks may emerge

There is still no consensus on tackling inflation, which has slowed significantly from its peak in 2022 but is still above 2% of central bank targets. Inflation, which has been above the target for two years, underlines how entrenched inflationary expectations have become. Inflation will average just over 2 percent in many key economies this year and even next year.

Core and service branch inflation rates continue to remain high. Unemployment is at or near record lows, and price pressures are easing but remain high. Considering central banks’ interest rate cut plans, the strong economy points to the risk of tightening again if inflation accelerates again. If a new US administration after the November elections imposes higher tariffs next year, it is possible that globalization will decline and geopolitical tensions will produce structural inflation.

A Higher Neutral Interest Rate After the Crisis

The expectation that interest rates will remain high for longer has been our long-standing view; This was consistent with rate cuts starting later and ultimately being fewer than markets had priced in.

The expectation that the Federal Reserve will keep interest rates constant for a longer period of time causes restrictions on the Eurosystem due to the risk of the euro losing value. The ECB started to increase interest rates after the Fed and took a break at a low level. Then, this month, it cut interest rates for the first time in five years. If the Fed postpones interest rate cuts, the ECB is likely to be cautious about further rate cuts, like many other central banks that have lowered interest rates, such as Canada, Sweden and Switzerland.

Our basic scenario is that the global stability interest, that is, the neutral interest, will be higher than before the pandemic due to inflation that shook the world with various shocks after the pandemic. This would be particularly risky for highly leveraged borrowers, who would need to adjust to the prospect of long-term tighter monetary policy.

Source: Global Economy: Soft Landing Reinforces Prospect of Higher-for-longer Interest Rates