Goldilocks outlook: Not too hot, not too cold

When central banks began hiking interest rates in the spring of 2022, in an attempt to quell inflationary pressures, debate around monetary policy lag times resurfaced. An oft-cited rule of thumb suggests that it can take anywhere from 18-24 months for interest rate moves to finally reach the real economy and impact consumer and business spending decisions. Having just crossed the lower threshold of that popular estimate, markets are on the lookout for any sign of slowing momentum.

After more than a decade’s worth of ultra-loose monetary policy and other extraordinary measures, efforts by the U.S. Federal Reserve, the Bank of Canada, the European Central Bank (ECB) and others to firmly anchor inflation to their preferred target ranges are beginning to have their intended effects. While this has helped significantly cool inflation, we also expect it to weigh heavily on growth over the next 12 months.

Signs of slowing are starting to show up in the labour market, notwithstanding surprising resilience so far this year. At the time of publishing Export Development Canada’s Global Economic Outlook report on Oct. 11, three month average job gains in the United States hit 266,000, down significantly from the pace of 423,000 a year ago. Meanwhile, wage growth is also running well-below the rates that employees had grown accustomed to last year, and excess pandemic savings are expected to be substantially run down as a result. This will limit the U.S. consumer’s ability to continue to spend over the next few quarters. EDC Economics expects U.S. gross domestic product (GDP) growth to fall to 2% in 2023 and just 0.6% in 2024. 

Despite the accompanying drop in inflation, we expect the Fed to raise interest rates by another 25 basis points before this hiking cycle is over, consistent with its intention to bring inflation back to target. While any future moves will very much depend on the data, with an eye toward its dual mandate to achieve both price stability and maximum sustainable employment, we expect the central bank to stand pat through mid-2024.

In Canada, the situation has mirrored that of the United States, but with the Bank of Canada acting earlier—both to increase interest rates in 2022, and move into reactive hiking in 2023. With Canadian consumers more heavily indebted, facing a 180% debt-to-income ratio, higher rates pose an even greater challenge to Canadian consumers. At the same time, Canada’s labour market has also begun to sputter. Slowing domestic demand, coupled with weaker growth out of our largest trading partner, will result in growth of 1.3% in 2023 and 0.6% in 2024.

Facing a fragile domestic economy, we expect the Bank of Canada to remain on the sidelines. Weaker growth will help ease pricing pressures, and we expect inflation to return to the upper-bound of its target range by late 2023. Similar to the Fed, we expect the Bank of Canada to only begin gradually cutting its benchmark rate in mid-2024, once inflationary pressures have settled. As a result, we expect the Canadian dollar to average US$0.75 in 2023 and US$0.76 in 2024.

China is facing a very different set of challenges. Following a faster post-reopening normalization of activity early in the year, the country is struggling with the lingering effects of a property slowdown (accounting for nearly one-third of its economy), reduced confidence, record youth unemployment and soft export demand.

We believe that a significant policy response to stimulate the economy is unlikely, due to high levels of local government indebtedness and a reluctance to continue to fund growth through credit. This will keep GDP growth below its already reduced target of around 5%, at 4.8% in 2023 and 4.4% in 2024. With China accounting for roughly 40% of global growth over the last 15 years, this weak performance will hinder growth elsewhere.

Euro Area growth of just 0.7% in 2023 and 1.1% in 2024 demonstrates this challenge. Germany—the bloc’s largest economy—is weighing heavily on the outlook, as it struggles to escape stagnation. The ECB will be challenged with balancing the need to manage persistent inflationary pressures against ongoing economic weakness across the bloc. We expect Frankfurt to hold its policy rate steady until next fall.

This generalized weakness across much of the global economy will depress demand for key industrial commodities and impact pricing for much of the commodity complex. Oil prices will remain more volatile, as OPEC+ works to offset weaker demand by managing supplies. While we forecast West Texas Intermediate crude oil prices to average $78 this year and $73 in 2024, we expect swings across both years as the market reacts to these conflicting dynamics.

The bottom line?

The impacts of central bank rate increases are finally hitting home in a real way in North America, Europe, and across other major economies. Meanwhile, China’s economy is grappling with a set of both cyclical and more structural challenges. Taken together, we expect the global economy to grow by a not-too-hot-not-too-cold 2.9% in 2023 and 2.7% in 2024.

This week, special thanks to Ross Prusakowski, director of our Country & Sector Intelligence team.

As always, at EDC Economics, we value your feedback. If you have ideas for topics that you’d like us to explore, please email us at economics@edc.ca and we’ll do our best to cover them.