Global economic outlook: Riding out the risks

In a world full of risks, we remain cautiously optimistic that major economies can enjoy a period of sustained economic growth as central banks gradually ease their monetary policies. Cyclical recoveries in the UK, the Eurozone and Japan can narrow the growth gap on the US and China.

Leaning back, one theme stands out. How economies ultimately fare will hinge on policymakers’ choices and geopolitical developments. If the tail risks are avoided, growth in major economies can surprise to the upside. 

Advantage UK. The shift back to the political centre after years of damaging uncertainty sets it apart as a place of relative stability. This should be a boon for the UK economy and its financial markets.  

 

Picking up the slack – We anticipate a broadening economic expansion across major economies over the next three years: with continued growth in the US and China matched by cyclical upswings in the UK, Eurozone and Japan as these economies recover from the 2022-23 energy and interest rate shocks. Recovering global trade can lift production and investment while less tight financial conditions support consumer spending and housing market activity. For the US, after a likely upside surprise in 2024, we are in line with consensus in 2025. In 2026 we look for US growth to surprise to the upside again. We project Eurozone growth in line with consensus in 2024, before it surprises to the upside thereafter. For the UK, we are above consensus in each forecast year (Figure 1).

A little help from central banks – Major central banks are likely to react to a further moderation in inflation by cautiously turning their monetary policies from tight to close to neutral. We look for the US Federal Reserve to lower the Funds Rate corridor from 5.5% (upper limit) to 4.25% by end-2025; the Bank of England to reduce the Bank Rate from 5.25% to 3.75% by end-2025; and the European Central Bank to lower the Deposit Rate from 3.75% to 2.75% by mid-2025. Structural inflation pressures tilt the risks to our rate calls to the upside.

Mind the tail risks – Political disillusionment across major parts of the world combined with growing West versus East geopolitical tensions make for an uneasy economic backdrop. In addition to the standard risk of central bank policy mistakes, we need to keep an eye on a host of geopolitical tail risks that could destabilise economic growth and cause turmoil in global financial markets.

For our detailed forecast tables see ‘Economic outlook: broadening expansion’

Figure 1:  Peel Hunt real GDP projections versus Bloomberg consensus

Annual data. Source: Peel Hunt estimates (PH), Bloomberg consenus (BB) taken on 26 July 2024

Overview: more growth, some inflation 

Real GDP outlook – modestly above consensus

We anticipate a broadening economic expansion across major economies over the next three years: with continued growth in the US and China matched by cyclical upswings in the UK, Eurozone and Japan as these economies recover from the 2022-23 energy and interest rate shocks (Figure 1). Recovering global trade can lift production and investment while less tight financial conditions support consumer spending and housing market activity.

• For the UK, our GDP calls are above consensus over our three-year forecast as fading headwinds, positive fundamentals and a political feel-good factor lift momentum. We project YoY growth of 1.2%, 1.7% and 1.8% in 2024, 2025 and 2026, respectively, whereas consensus expects 0.8%, 1.3% and 1.5%. In the Eurozone, we are close to consensus in 2024 (0.7%), but ahead thereafter at 1.5% (1.4%) in 2025 and 1.6% (1.3%) – consensus in brackets. Our better-than-expected Eurozone outlook is driven by a continued catch-up in peripheral economies, and a small positive surprise in France, while Germany disappoints.
• In the US, resilient domestic momentum hints at a slight upside surprise in 2024 – our 2.5% call is a notch above consensus (2.3%). However, we expect the lagged impact of tight monetary policy to lower growth to 1.8% in 2025 – in line with consensus. In 2026, fiscal support and less tight financial conditions can lift growth to 2.2% - 0.2ppt above consensus. 
• China’s growth is slowing on trend as high debt and an ageing population hurt demand. Our GDP call for China of 4.8% in 2024, 4.4% in 2025 and 4.2% in 2026 are roughly 0.1ppt below consensus over the three-years, on average. In Japan, current Chinese weakness is likely to restrain activity in 2024 – and our -0.2% call is 0.3ppt below consensus. Thereafter, we look for a cyclical recovery in Japan that lifts growth to 1.2% in 2025, followed by an above-potential 0.8% gain in 2026. Our Japan calls for 2025 and 2026 are in line with consensus.   

Figure 2: Peel Hunt projections for real GDP

% YoY. Peel Hunt projections for 2024-26. Annual data. Sources: ONS, BEA, Eurostat, China National Bureau of Statistics, Cabinet Office of Japan

Monetary policy turns less tight as inflation moderates

We expect inflation across major western economies to moderate between 2024 and 2025 as the mostly energy-related surge in 2022 and 2023 fully fades, inflation expectations remain well behaved, and wage growth moderates further.

In 2026, inflation is likely to rise again and stay modestly above central banks’ 2% targets as long-term structural factors including rising trade frictions and labour shortages caused by ageing populations push up prices via higher input costs and wages.

• In the UK, we project that inflation will fall from 2.5% YoY in 2024 to 2.1% in 2025, before ticking up to 2.3% in 2026. We expect a similar pattern for the US (2.9%, 2.5% and 2.4%) and Eurozone (2.4%, 2.0% and 2.1%) across 2024, 2025 and 2026, respectively. Stronger demand growth will likely keep inflation slightly higher in the US than in Europe.
• Japan appears to be tentatively on track to escape its decades-long disinflation. Although we expect inflation in Japan to moderate from a 2.5% overshoot in 2024, it can remain in the 1.8-2.0% range in 2025 and 2026. In China, inflation is on a different trajectory owing to a host of mainly domestic challenges. We expect headline inflation to pick up from 0.4% in 2024 to 1.5% in 2025 and to 1.9% in 2026.

Step-by-step, major central banks are likely to react to moderating inflation by lowering their key policy rates to close to, but still a notch above, longer-run neutral levels (Figure 3).

• In the UK, we expect the Bank of England (BoE) to cut the Bank Rate twice in 2024, by 25bp each time, followed by four more 25bp cuts in 2025 – reducing the Bank Rate from 5.25% to 3.75% by end-2025.
• In the Eurozone, we look for the European Central Bank (ECB) to lower the Deposit Rate from 3.75% at present to 2.75% by mid-2025, with two further 25bp cuts coming before the end of 2024.
• In the US, we project that the Federal Reserve (Fed) will lower the Funds Rate corridor from 5.5% (upper limit) to 4.25% by the end of 2025, with two 25bp cuts coming before year-end.  

Figure 3: Peel Hunt projections for central bank policy rates

In %. Shaded area shows projection. Quarterly data. Sources: Federal Reserve, ECB, BoE, Peel Hunt

 

Assumptions and risks

Our call for sustained economic growth across major economies rests on three key assumptions:

1. Inflation moderates in 2024 and 2025 in line with the expectations of central banks and financial markets. A further moderation in inflation is necessary for the Fed, the ECB and the BoE to gradually remove monetary tightening and ease financial conditions to support demand growth and employment.
2. No new negative global supply shocks. The key sources of risk are energy and commodity markets. However, we also need to watch for sudden acute disruptions to global supply chains and key shipping routes. As past shocks fade, improving global supply growth can support real economic activity and keep input cost pressures under control.
3. No serious protracted bouts of financial instability. We need to keep a close eye on the small but serious risk that misguided fiscal policies in the US (pages 14-15) and in France (page 19) could trigger bond market turmoil due to inflation and debt sustainability concerns. A tantrum in the US treasuries market could destabilise global markets.   

Two-sided macro risks

While an unusually high number of tail risks (see final section below) tilt the overall risk balance in our projections to the downside, if we abstract from these potential fault lines, the core macro risks are roughly balanced.

• On the upside: The diffusion of artificial intelligence (AI) technologies promises to revolutionise supply and lift productivity across a host of sectors. The prospect of a return to more historically normal rates of growth in per capita GDP and productivity could help to contain political and geopolitical tensions.
• On the downside: We need to watch the risk that central banks leave it too long to cut interest rates. In case of surprise downturns in 2H24 or early 2025 caused by central bank policy missteps, we would look for
  V-shaped rebounds in 2H25 and 2026 as policymakers slash interest rates to levels well below those set out in our base case.

Tail risks in the age of instability

Political disillusionment across major parts of the world combined with growing West versus East geopolitical tensions make for an uneasy economic backdrop. In addition to the two-side macro risks set out above, we need to keep a close eye on five serious, but low probability, downside tail risks that could destabilise the global economy and financial markets:

1.    a US lurch towards isolationism under a second Trump presidency;

2.    a major tit-for-tat trade war between the US, Europe and China;

3.    a spillover of the Russian-Ukraine war into a NATO member;

4.    a broadening of the Israel-Palestine conflict into neighbouring countries; and

5.    any attempt by China to annex Taiwan using military means.

 

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Kallum Pickering

Chief Economist