Global Growth Outlook 11/2022: Transatlantic lull

GLOBAL GROWTH OUTLOOK

Transatlantic lull Tough times ahead for Europe and the United States due to the war

GLOBAL GROWTH OUTLOOK

Juni 2022

The global economy is set to grow three percent this year and a good 2.25 percent next year. The transatlantic economic region is approaching a period of pronounced weakness. This is likely to last longer in the euro region than in the United States. In 2023, a good three quarters of global growth will occur in the Asia Pacific region, followed by three fifths in 2024. ▪

In this sluggish environment, we expect real exports of goods and services in Germany to grow by just 2.5 percent (2021: 9.7 percent). ▪

Die amerikanische Lokomotive der Weltwirtschaft Aufschwung im Norden, Risiken im Süden

We anticipate a global inflation rate of around nine percent this year, the highest level for 25 years. Next year, inflation should drop to five percent. Industrialised countries must combat inflation without delay. Monetary tightening needs to be stepped up in the United States, the United Kingdom, the Euro area and in some developing and emerging countries to avoid second round effects. ▪

Financial policy must become more targeted. Legislators in the major countries should tailor their support measures for private households and enterprises more precisely and combine them with incentives to save energy. ▪

Economic policy should rapidly set investment incentives. The current weak period is likely to dampen investment activity significantly in the transatlantic region. Higher public sector investment and stimulation of private investment in climate protection and digitalisation are needed to lay the groundwork for growth and an upturn in 2024/25.

Content

War, the energy price shock and inflation must be countered with stabilisation policies .........2

Monetary policy: combating inflation is top priority .....................................................................11

Financial markets adapting robustly but risks remain..................................................................15

Japan bucking the trend...................................................................................................................18

Global industrial production............................................................................................................18

Global trade........................................................................................................................................21 USA.....................................................................................................................................................22

China: growth outlook......................................................................................................................25

Economy in EU and Europe still resilient but recessions here and there are almost unavoidable 29 Germany 31 Sources 32

War, the energy price shock and inflation must be countered with stabilisation policies

Inflation shock puts the brakes on global economic activity

The global economy is currently in the throes of an inflation shock. The factors driving up inflation are diverse and are not identical in the United States and in Europe but resolute monetary and financial policy responses are required on both sides of the Atlantic. Since the beginning of the year, the major central banks have launched the most rigorous monetary policy tightening measures seen for several decades. The energy and food price shocks, caused above all by the war, have led to soaring inflation in many parts of the world in the last few months, particularly in the United States, the United Kingdom, the euro region and many emerging countries, and prompt action was needed. The impact of the imbalances caused by the pandemic have also not yet been overcome. In the United States, stimuli from the country’s financial policy in 2021/21 and a very tight labour market with high pressure on wages drove inflation up even more.

Pronounced transatlantic lull in 2023

The disruptions, uncertainties, and price pressures caused by Russia’s war against Ukraine have greatly increased the risk of recession for the US economy and the major European economies, while a few European countries are still only experiencing a mild slump in growth. The monetary and fiscal policy measures needed to combat inflation have already caused a deterioration in financing terms, above all for high risk investments, and have significantly changed the exchange rates of the major currencies. The swift and extensive interest rate hikes made by the US central bank have, in turn, had a major effect on the funding situation of developing and emerging countries. Vulnerable economies are already bracing themselves for the typically associated currency, bank and economic risks.

Some supply disruptions are ebbing off

As the global economy cools, commodity prices have dropped somewhat, particularly crude oil, metals and, most recently, gas. Supply chain problems have also gradually eased up.

Central banks have to account for higher stabilisation costs

The crisis is presenting monetary policymakers with a problem they have not had to confront for a long time, namely to prioritise a rapid stabilisation of price levels over economic growth in order to avoid a permanent and costly stabilisation course further down the line. Fiscal policy, on the other hand, needs to strike a balance between avoiding slumps in production, employment and incomes and cushioning the shock on the one hand, while not undermining efforts to keep prices stable on the other. The initial responses of the OECD governments to the crisis focused on cushioning the shock for low income private households and energy intensive companies, although the measures taken were not always sufficiently precise.

Energy price shock keeping North Atlantic economies on tenterhooks

Massive cost shock for private households and enterprises

The gas and electricity prices have eased slightly from the record levels seen over the summer but are still at a high level and far above their long term average in the pre crisis period. The economic slowdown had already curbed the demand for oil and oil prices considerably, but electricity and gas prices hit exorbitant levels at times: in Europe, for example, they were 13 times higher than their long term pre crisis average. The OECD expects the energy expenditures (coal, oil, gas, electricity) of the major European economies to almost triple, rising from between three to five percent of economic output (2019 2021 average) to between nine and 13 percent of economic output. By comparison, in the United States, energy expenditure is set to jump from three to six percent, and in Japan from four to eleven percent. These costs are putting a huge burden on households and enterprises and represent a terms of trade shock, particularly for Europe and Japan, while the United States, as a net exporter of energy, is experiencing a redistribution within its borders (OECD 2022).

Lost purchasing power of private households is the biggest braking factor

At present, the most damaging impact on the economy is the decline in the income of private households, shrinking consumer confidence and the expected slump in retail sales and real consumption expenditure. The anticipated Covid wave in autumn and winter is likely to aggravate the situation further, particularly in Europe.

Investments also suffering

The second major impact of the crisis is a curbing of corporate investment. Companies surveyed anticipate considerable downward risks particularly regarding expectations and this is dampening investment activity. The swift and hefty interest rate hikes currently being used to combat inflation are leading to substantially more restrictive financing conditions in the banking sector and on the bond and stock markets. Furthermore, the soaring dollar is having a mixed impact on the price competitiveness of European exports (positive) and inflation (negative).

Inflation rising drastically across most continents

Inflation is a problem almost worldwide

Inflation rates across the world already started going up in 2021, due to rising energy commodity prices and an overheated demand for goods on account of supply bottlenecks and high transport costs. But it was the shock of the war that saw prices shoot to their highest level in forty years by the autumn. According to IMF estimates (IMF 2022), price levels are likely to rise by more than nine percent globally this year, and next year by almost five percent. Industrialised countries are set to fare better with inflation rates of 7.5 percent this year and 3.1 percent next year compared to developing and emerging countries with 10.9 percent this year and 6.1 percent next year. In the third quarter 2022, the median inflation rate across industrialised countries stood at 9.6 percent and for emerging countries at 10.8 percent, in other words three to four times the normal target level of two or three percent.

Inflation forecast* for 2022 and 2023

8.1

*in percent, year on year

Source: IMF

Upsurge in prices in the United States and United Kingdom

In September, inflation in the United States was at over eight percent, in the United Kingdom at almost ten percent and in the euro area it even reached 10.7 percent in October. In the emerging and developing countries, inflation had already passed the ten percent mark in the second quarter and is likely to have risen to eleven percent in the third quarter. Core inflation (excluding food and energy) also rose steeply, though slightly later, and is currently at five percent for goods and over two percent for services in industrialised countries and at over nine percent and over three percent respectively in developing and emerging countries. In many of the major economies, there is still a considerable gap between wholesale and consumer prices for gas and electricity, which are being closed with the help of price interventions and subsidies. In any case, energy prices are putting considerable upward pressure on inflation.

Rising inflation no longer fuelled only by energy and food prices

In the euro area, the prices of other goods and services replaced energy and food as the main driver of inflation over the summer, while in Asia, Africa and Latin America inflation rates are still more strongly influenced by energy and foods. The cost increases for energy commodities and foods have not yet been fully passed through to consumer prices. The IMF therefore expects core inflation to reach 6.6 percent by the end of the year in industrialised countries. In the United States, which responded with monetary tightening at an earlier stage, the peak inflation level of over six percent at the start of the year should drop to below five percent in the first quarter of 2023. In Europe, inflation should not exceed the five percent mark and should drop to around four percent in the course of next year.

USA Euro area Germany France Italy U. Kingdom Japan China

Some goods categories seem to have passed peak of inflation

At least the prices for agricultural products affected by the war dropped again in autumn, as did those for metal raw materials due to weak industrial momentum in China. Two major drivers pushing up prices this year have thus been significantly curbed. The IMF also expects that the price of oil, after rising by a good 40 percent this year, will next year level off around ten percent lower than this year. Non fuel commodities are also forecast to drop by a more moderate six percent. Individual transport costs of the international movement of goods also decreased substantially and now only account for around 0.15 percentage points of inflation in the G20, according to OECD estimates. The IMF regards the long term inflation prospects as relatively stable. Obviously, much depends upon whether the initial loss in real wages will again see a robust upward correction in the wage negotiations. There are no indications of a large scale wage price spiral at present, but this cannot be ruled out in the further course of the crisis.

The OECD is also expecting inflation rates of over eight percent on average in the G20 countries this year and a good 6.5 percent next year. Inflation in the United States is forecast to drop sooner and faster, from currently over six percent to just over 3.5 percent in 2023, than in the euro area, where it is expected to remain at above six percent next year too. The United Kingdom is likely to see rates closer to the euro area than the United States. Only Japan will have a satisfactory rate of two percent this year, while China, where pressure on prices is low anyway due to the weak economic situation, only has an inflation rate of around three percent despite monetary easing. In Brazil, India, Russia and South Africa inflation is expected to remain above five percent both this year and next, while Australia, Canada, Korea and Mexico are on track to bring inflation back below five percent. Turkey is an exception here, with the government refusing to change its monetary approach despite exorbitant inflation that has probably reached the triple digit realm.

World economy facing a very weak year

Current year still moderately good

Global economic growth is likely to drop to only around three percent this year (IMF: 3.2 percent; OECD: three percent). The Chinese economy has slowed to this rate due to its numerous and extensive Covid prevention measures, while the United States should reach growth of over 1.5 percent and the euro area a good three percent. While emerging and developing countries are set to outperform the global average growth by half a percentage point (3.7 percent), there are tangible differences particularly between energy commodity exporters in the Middle East (over five percent) and Latin America (3.5 percent). Russia’s economic downturn is only expected to amount to around three to four percent.

Clear slowdown over course of the year

Global economic activity gradually lost pace during the year. In the second quarter, global economic activity dipped marginally (down 0.1 percent quarter on quarter) before coming in at just over zero in the third quarter (good summer tourism, pick up in China). But the fourth quarter and, above all, the first six months of 2023, are almost bound to see negative growth due to receding economic activity in the EU and the United States. Economic activity in China and Asia seems to have bottomed out this year and should gradually begin to pick up again.

2023 set to be very weak

Next year, we expect growth to be among the lowest recorded in the last 40 years. The lull in the United States and in the EU will result in a very weak year for the global economy in 2023, with growth forecast to be down to only a good 2.25 percent. That is an incredibly low level of growth [average growth over the last 32 years (1990 2021) was 3.4 percent]. Lower rates were only seen in 2009 (financial crisis, zero growth) and in the Covid year 2020 (minus three percent). 2023 may well turn in the third worst result in the last 32 years. The IMF expects a good third of all economies to register a decline in economic activity. The IMF forecasts higher global economic growth (2.7 percent real growth) than the OECD (2.2 percent) (IMF 2022, OECD 2022).

Transatlantic recession affects labour market less than in the past

The ups and downs of the economy in the last four years would, in earlier times, have triggered a substantial rise in cyclical and structural unemployment in most industrialised countries. Labour markets are however experiencing a shortage of supply despite the pandemic and current turmoil of the war. Unemployment rates have reached long term lows in most countries, with only Greece and Spain with rates of over ten percent. The OECD average is at five percent and is expected to rise by about half a percentage point next year. The ratio of vacancies to the number of unemployed is very high. Nominal wages are generally rising more strongly than in the past even though real wages are currently being eroded by inflation. Unit costs are also rising markedly in many countries. Only in terms of labour market participation rates are there outliers such as the United States and the United Kingdom, which have not fully recovered from the effects of the pandemic.

Downward risks dominate the picture

The number of possible downward risks for the forecast is unusually high and, in many cases, there are no historical precedents with similar constellations. The main factors include a further escalation of the security situation, particularly a military escalation of the war in Ukraine, with knock on effects for the economy; the precise scale of monetary tightening by the leading central banks and their combined international impact; the effects of the real economy problems on the financial markets and exchange rates (strong dollar) and the corresponding vulnerabilities of highly indebted or commodity importing emerging and developing countries; a particularly cold winter in Europe and the associated risk of rationed gas supplies, which would lead to an incalculable reduction in industrial production; and finally, an unexpectedly strong new wave of Covid infections with the typical restrictions in production and supply, particularly regarding services.

Expectations for recovery timescale based on hope

The war in Ukraine has hit the global economy hard, leading to a substantial drop in growth and a massive inflation shock. Unlike most forecasters, we believe that a recovery by summer 2023 is unlikely and expect the present difficulties to persist with global production levels only recovering gradually over the summer of 2023, followed by a second hard winter half year 2023/24 and a slow pick up starting in spring 2024, initially in the United States and then in Europe. The European economy is usually three to four quarters behind its US counterpart. The United States is likely to remain in a weak period or even undergo a short recession at least until autumn 2023 before gradually picking up again in 2024. In Europe, the economy may recover briefly over the summer 2023 but is then likely to face another hard winter (very high gas prices, rationing risks, markedly increased interest rates and

financing costs, investment caution, low purchasing power, etc.). In this setting, strong drivers of growth are unlikely both externally and internally.

Global trade expected to be sluggish next year

In this situation, global trade is also likely to show very little momentum and grow by just 1.5 percent, although here too, uncertainty about developments ahead is high. The WTO is only expecting growth of a good one percent, while the OECD considers three percent to be within reach. Trade growth in Europe and America will certainly be below par, while foreign trade in China will gather more momentum.

Sentiment indicators slump but auto industry is finally brightening up

The major sentiment indicators have recorded hefty declines in the last few months. Consumer confidence among OECD countries has tumbled the most, while industry confidence has fallen somewhat more slowly. The global purchasing manager indices have faltered since the outbreak of the war and are now signalising contraction in both manufacturing and services. The euro area is entirely reflecting these global trends. In the United States, services were deep into contractionary territory over the summer but have since recovered. Manufacturing also dropped from over 55 to just over 50, thus still managing to remain in expansion territory. Even in China, indicators dropped below the threshold value of 50. In Germany, all components are clearly in contractionary territory. At least global momentum in the automotive industry has picked up slightly, with a tangible revival since the summer. The recovery is more pronounced in China than in the United States or Europe, a trend that is likely continue into next year.

Economic sentiment indicators*, OECD

Jan 20 Jun 20 Jan 21 Jun 21 Jan 22 Oct 22

Business Tendency Surveys (Manufacturing) Consumer Opinion Surveys Leading Indicator *seasonally adjusted (index=100)

Vehicle registrations*

2,0

1,5

1,0

Source: Macrobond 0,0

2,5 2021 2022

0,5

2.5 2.0 1.5 1.0 0.5 0.0

USA (vehicle sales and registrations, passenger cars and small vans, seasonally adjusted)

China (passenger cars) Euro area (passenger cars, calendar adjusted) *number in millions

Source: Macrobond

United States and many European countries in economic lull while China and Japan recover

Economic momentum is highly divergent among the major economies. Following a weak start to the year 2022, the United States are on track for very low growth next year, due to monetary tightening and impetus from its fiscal policy ebbing out. Economic growth there is likely to drop to 0.5 percent next year following around 1.5 percent this year. For the Euro area, we also forecast very weak growth of 0.25 percent in 2023 on account of the highly uncertain energy situation. The economic prospects for the United Kingdom are similarly modest. In Japan, on the other hand, we expect growth of a good 1.5 percent in both years, which is well above its potential growth rate. In the People’s Republic of China, economic activity could pick up slightly provided the economic impact of the country’s Covid measures is reduced next year.

Growth of real gross domestic product in 2023 compared to previous year (in percent)

Global economy +2¼ Euro area +¼ World trade +1½ EU +¼ USA +½ Japan +1½ China +4½

Source: BDI

Regional outlook: slowdown, though less in Asia than in Latin America

The advanced Asian economies (Australia, Korea, Taiwan, Singapore) are set to lose a little momentum in 2023 but will still grow by rates of between two and three percent. Growth in India will remain above six percent, the ASEAN region at just over five percent. The major South American economies are heading for a substantial slowdown, with growth in Brazil expected to be down to one percent, and Argentina and Columbia down to two percent. Chile is heading for a recession. The countries of the Near and Middle East are forecast to grow by around 3.6 percent following high growth of five percent in 2022. The oil exporting countries in southern Africa should expand by a good 3.5 percent in both years, while growth in South Africa is facing a slowdown from two to one percent. The remaining low income countries should accelerate moderately from 4.5 to over five percent growth.

Forecast summary: Growth in real GDP 2022/2023 in percent

2022 2023

IMF1 OECD2 EU COM3 IMF1 OECD2 EU COM3

World 3 2 3 04 3 0 2 7 2 24 3 3

USA

1 6 1 5 2 9* 1 0 0 5 2 3*

China 3 2 3 2 4 6* 4 4 4 7 5 0*

Japan 1 7 1 6 1 9* 1 6 1 4 1 8* EU 2.7 1.5

Euro area 3 1 3 1 2 6 0 5 0 3 1 4

Germany 1 5 1 2 1 4 0 3 0 7 1 3 France 2.5 2.6 2.4 0.7 0.6 1.4 Italy 3 2 3 4 2 9 0 2 0 4 0 9 Spain 4 3 4 4 4 0 1 2 1 5 2 1

U. Kingdom 3 6 3 4 3 4* 0 3 0 0 1 6* India 6 85 6 9 7 4* 6 15 5 7 6 5* Brazil 2 8 2 5 0 7 1 0 0 8 1 5 Russia 3 4 5 5 10 4* 2 3 4 5 1 5*

1: IMF (October 2022)

2: OECD (September 2022), Forecast for India for fiscal year beginning April

3: European Commission (July 2022, *May 2022)

4: Forecast on basis of 70 percent world GDP (PPP of 2013)

5: Information on India for the fiscal year in current prices

Monetary policy: combating inflation is top priority

The central banks in the transatlantic region are combating inflation by rigorously tightening the monetary reins. The policy response to the dramatic upward trend in inflation has been stronger and swifter than in the past. In autumn and winter 2022/2023 we are likely to see further rapid and hefty interest rate hikes and other measures to further tighten the monetary course. Most central banks are trying to avoid interest rates settling well above the target level, which is a risk if inflation expectations of private households and wage negotiations adapt to the new level. A point of contention is how far the central banks need to go, especially as the impact of interest rate hikes and quantitative tightening along with the international feedback effects will only fully unfold in the later part of 2023 (Obstfeld 2022). The OECD estimates that the median cost of the concerted efforts will be about one quarter of a percentage point of growth and half a percentage point of inflation over the next two to three years

as the usual mechanism of taking independent action to curb the price level through an appreciation of the currency does not work in the collective case. In general, past experience will only be of limited use in finding the right dose of monetary tightening, so there is certainly a risk of either undershooting or overshooting. The consensus among the major central banks over the summer was that the reins should be tightened more rather than less.

FED tightening hard

Rapid interest rate hikes and quantitative tightening are the order of the day

The US Fed has tightened the monetary reins very rigorously since the beginning of the year, which is not surprising given that monthly inflation had climbed to over eight percent (consumer price index). The policymakers have already hiked the interest rate up by 3.75 percentage points since the beginning of the year and are expected to increase rates from their current level of between 3.75 and four percent up to 4.6 percent (median value) in spring 2023 (as of September). At the FMOC’s meeting on 1 and 2 November, the decision was made to increase interest rates by 75 basis points for the fourth time in a row. Governor Powell also indicated that yet more interest hikes are on the horizon (Fed 2022a). The OECD also believes that it will be necessary to raise interest rates to between 4.5 and 4.75 percent. The financial markets are already anticipating a further hike on this scale or even slightly higher. In addition, the Fed started on a course of quantitative tightening at the beginning of the year and has been reducing its asset portfolio. This should drive long term bond yields up by between one half and one whole percentage point and have a corresponding tightening effect. The financing terms in the United States have also become considerably more restrictive and the rapid appreciation of the external value of the US dollar is putting an additional damper on economic activity.

Tightening already impacting financial markets and real economy

The monetary tightening has already affected bond yields and investments in the United States and is set to bring inflation down significantly in 2023/24, albeit at the price of a substantial cut in growth. In September, decision makers expected an average inflation rate of 5.4 percent in 2022 and 2.8 percent in 2023 (with core inflation of 3.1 and 2.3 percent) (Fed 2022b).1 The labour market is still marked by tight supply and very high wage increases. Over the last two years, average hourly wages in the private sector have increased by between four and eight percent in most months. The ratio of vacancies to the unemployed dropped slightly from its all time high of two to one before turning upwards again in September. Pressure on core inflation is set to remain high for the time being. Some observers expect the Fed to tighten the reins even more than anticipated so far and raise the interest rate to over five percent (Dynan 2022, Deutsche Bank 2022). The risk of economic output contracting more than forecast next year is therefore high.

ECB tightens monetary course

The strong upward flight of inflation has repeatedly taken the ECB by surprise this year. Following several months of debate, the ECB changed its monetary approach in the second quarter and over the following six months, it reviewed its entire toolbox of monetary policy. In a first step, the ECB stopped net purchases in its asset purchase programmes. It then increased interest rates and terminated its

1 The FED bases its calculations on the consumer spending deflator of private households, not the consumer price index, which is currently two percentage points higher (a good one percent for the core rate)

forward guidance. In October, it added measures to restrict the supply of liquidity to commercial banks. A review of the asset purchase programmes is on the agenda for December, with the aim of deciding the further course for the quantitative tightening of liquidity.

Interest rate hikes anticipated

The ECB is likely to raise the key interest rate (deposit rate) substantially from its current level of 1.5 percent by spring 2023. At present, the three interest rates stand as follows: the deposit rate is at 1.5 percent, the main refinancing rate at two percent and the marginal lending rate at 2.25 percent. How far the ECB will go will depend on the severity of the slump in economic activity and the expected slowdown of price increases in the Euro area. The ECB is currently still anticipating growth of 0.9 percent for the Euro area next year, but a more realistic perspective lies between this forecast and the downside scenario (minus 0.9 percent) (ECB 2022); the 2023 forecast will probably be downwardly revised again slightly in December. The markets expect a key interest rate (for the deposit facility) of between 2.5 and three percent in the first six months of 2023. The OECD believes the rate needs to be as high as 3.25 percent (OECD 2022).

In its meeting on 27 October, the ECB noted substantial progress in the downscaling of monetary accommodation but made it clear that further hikes were to be expected. The ECB also decided to raise the terms and conditions of the third series of targeted longer term refinancing operations for credit institutions and offer banks additional voluntary early repayment dates to reduce liquidity in the real economy.

Discussion will soon become heated

Once the deposit interest rate climbs above two percent, public debate will become more strident as it will not be possible to precisely quantify the contrary effects (upsurge in prices in 2023 as energy purchase prices are transferred to consumers versus slump in economic activity and demand) and there is considerable factual uncertainty about the effectiveness of further interest rate hikes. In our opinion, the producer price trends indicate that Euro area inflation will continue to be very high in the first six months of 2023 and only gradually subside towards the end of 2024. Whether inflation can be reined in to an annual average rate of 5.5 percent depends largely on further developments in the security situation. Wage agreements will only lift inflation marginally in the foreseeable future, as the monthly increase in wages had not exceeded 2.5 percent by the summer and there are no indications of high wage agreements on the horizon. Although the ECB is expecting the wages of Euro area employees to increase by four percent this year and 4.8 percent next year (and four percent in 2024), the impact on inflation will remain limited. The ECB has nonetheless reasoned that the inflation expectations of citizens are too high, that higher interest rate hikes are required than in the past to achieve the same effects (the economy as a whole has become less sensitive to interest rate changes) and, in cases of high uncertainty, a more rigorous course is the better choice. Factors currently alleviating inflationary pressure are the oil and gas markets, although bottlenecks among refineries in Europe mean that the low Brent oil price will probably not have an even impact on final product prices. The ECB is also closely monitoring the external economic effects of US monetary policy. Much of the tightening of the financing terms in Europe is a direct result of US monetary policy (Lane 2022), although the contrary real economic effects of the appreciation of the dollar on production (increased net exports to the dollar region) and inflation (through import prices from the dollar region) need to be factored in. The ECB has nonetheless underlined that the risks for inflation and growth remain high. The further course of policy will be based largely on the new economic forecasts in December, EU

decisions on energy policy for the gas and electricity markets, the fiscal support measures of the member states for 2023 and the actual trends in bank lending.

Transmission channel uncertain and complex

After years of unconventional measures, the various transmission channels of the ECB’s monetary policy have become very divergent. This means that a change in course involves a degree of uncertainty (in that the retraction of unconventional measures does not always have the same effect in the opposing direction as the introduction of these measures). The ECB will therefore be keeping a very close eye on how its measures play out. It is already clear that construction and real estate financing has contracted more sharply than corporate financing, which was temporarily stimulated by special requirements but is likely to come under pressure in the next few months due to more restrictive lending standards, higher lending rates and the credit rating migrations typically seen during a downturn, even if the demand for corporate lending itself is also likely to drop. Lending to households and to the residential accommodation sector should decline more rapidly (see Lane 2022 for details).

Many other central banks towing the line

Some central banks have already sharply raised their interest rates. Canada has already hiked its interest rate by 3.5 percentage points to 3.75 percent. Hungary had to make a ten percentage point hike while Poland remains at five percent. The central banks of New Zealand, Australia, Norway, Sweden and Switzerland have also raised their rates substantially since the beginning of the year (by 2.75, 2.5, 1.75, 1.75 and 1.25 percent respectively). The Bank of England is also likely to increase its key interest rate from currently three percent to four percent or more (OECD 2022). Japan is the exception here with interest rates trending sideways around zero. China, meanwhile, is pursuing an expansionary monetary course to bolster its sluggish economy. The high inflation has also forced many central banks in developing and emerging countries to raise their interest rates substantially. Brazil had increased rates by as much as twelve percentage points since the start of 2021 (back to a good ten percentage points now), Mexico by six percentage points and South Africa by just two points. Russia’s central bank had initially raised the key interest rate considerably following the outbreak of the war but has since brought it back down again.

Difficult balancing act for fiscal policy

Support measures launched for households and enterprises

Most industrialised countries have launched quite extensive support measures. In many cases, the initial steps taken were not very targeted, consisting for example in general reductions in value added tax on fuels and price interventions. These measures were often not tied to reducing the consumption of scarce commodities. Some countries are now gradually adopting more targeted support measures, a process that tends to be hampered by administrative and information related obstacles. In general, low income private households, the elderly and residents of rural areas are particularly affected and should receive most support. Support measures for the private sector tend to focus on energy intensive enterprises; here too, the precision of the measures is crucial. The volume of these types of measures often amount to between two and three percent of GDP. In Germany, they are likely to add up to just over four percent of economic output in 2023 and will serve to stabilise economic activity. The measures taken by Germany, Italy and France in particular, do however, raise general questions about competition in the EU, especially as the response to the crisis, as in the case of Covid, is much stronger

in financially robust countries than in the others. At least the EU has managed to adapt its state aid temporary framework.

Fiscal policy in Europe and Japan moderately restrictive, but appropriate

Fiscal policy measures are being used primarily in Europe and Japan to cushion the worst impacts of the food and energy price shock for private households and enterprises. France and Italy both adopted packages of around three percent of GDP in the first six months of 2022. In Germany, the coalition government’s relief packages I III (headline volume: 95 billion euros) only amount to 1.5 percent of real stimulus, but further measures are planned to run between December 2022 and April 2024 with a volume of up to 200 billion euros (five percent). The total volume in 2023 would then be over four percent of GDP and thus the highest among EU members. This kind of support will soon be bolstered by the distribution mechanisms for the implementation of the cap on electricity prices and further measures on the gas market in various countries. Without these measures, the fiscal policy in the Euro area for 2022/23 would have been strongly restrictive measured against the structural primary surplus, but with these measures it will only be marginally restrictive as the special expenses for the pandemic are terminating at the same time.

Japan’s fiscal policy is not yet fully laid out. Support measures to shield private households as well as enterprises from the energy shock have been introduced. In late October, Japan’s prime minister announced a further large scale package of measures. It remains to be seen whether Japan will also manage to structurally improve its budget.

The fiscal policy of the United States, on the other hand, is restrictive and the structural situation should improve by a good two percentage points. In Canada and Australia, fiscal policy is also clearly focused on consolidation.

Financial markets adapting robustly but risks remain

The global supply shock and the resulting impact on inflation have triggered a turning point across all market segments. Major changes have taken place on the financing side this year, and investment wise too, the deck has been reshuffled with the valuation of stocks, bonds and real estate all adjusting at the same time. Stocks and currencies were particularly quick to adjust, while bonds and bank loans took somewhat longer.

Strong dollar, not our problem…

Currency markets reacted particularly strongly to the changes. The recent developments are slightly reminiscent of the strong appreciation of the US dollar under Paul Volcker’s Fed and the fiscal policy of the first Reagan administration. The euro, pound sterling, yen and renminbi have all depreciated strongly against the dollar since the beginning of the year. By September, the dollar had appreciated by 13 percent (nominal, trade weighted) compared to the annual average of 2021; the external value of the US dollar rose by 15 percent against the euro this year, by ten percent against the renminbi, by 20 percent against the pound sterling and by 25 percent against the yen (IMF 2022). These trends reflect the development of the key interest rate and yields in the United States. Real long term yields have now also risen again considerably. The currencies of most developing and emerging countries also depreciated sharply against the dollar, forcing governments to take strong countermeasures. Volatility has thus been high all year. The hardest hit currencies include the Turkish lira (down more

than 15 percent since May) and the Argentinian peso (down more than 20 percent). Most of the currency fluctuation took place in the first six months of the year. The euro has depreciated by around seven percent over the last six months, and thus on a similar scale as the renminbi. The pound sterling dropped ten percent, and the yen twelve percent. Only the rouble went through a major rollercoaster ride and has been up against the dollar since May. We have not yet seen the end of the adaptation process. The successive interest rate hikes of other central banks will, however, have a stabilising effect as the interest rate differences compared to the United States decline. The real trade weighted changes are naturally overshadowed by the headline grabbing relations to the dollar. The euro has depreciated seven percent against the dollar and the yen 18 percent over the year so far.

Exchange rates against the US dollar

1,25

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1,05

1,00

1 25 1 20 1 15 1 10 1 05 1 00 0 95

Euro (left axis) Pound Sterling (right axis)

Source: Macrobond

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1,0 0,95

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1 0 0 8 0 6 0 4 0 2 0 0 95

105

Renminbi (right axis) Yen (left axis)

Bond yields in the transatlantic region consistently going up

7,4

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6,8

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155 6,2

7 4 7 2 7 0 6 8 6 6 6 4 6 2

The bond markets are divided into two. While yields in Japan are still bobbing around zero, propped up by its monetary policy, and in China they have stagnated around three percent for some time now, yields in the United States are up by 2.25 percentage points compared to the start of 2022, and, in the European countries by between two and three percentage points (Germany, France, United Kingdom: up 2.25 percent; Spain: up 2.5 percent; Italy: up three percent). In the last six months, the upward trend in the United States has been less steep than in Europe as the financial markets anticipated the interest rate hikes of the Fed at an early stage. Bond yields in the major developing countries have, in contrast, barely budged since spring (Mexico, India, Indonesia) or decreased slightly (Brazil, Russia).

Corporate bond yields increased just as vigorously. High risk bonds in the United States have become markedly more expensive but typical investment grade credit rating categories have also become correspondingly pricier in Europe and the United States.

Price adjustments on stock markets still underway

The world’s major stock markets were very quick to factor in the bad news. Share prices in most countries have already dropped in anticipation of a mild recession or weak growth. The US stock market, in particular, has come out a period of high valuation with strong corporate profits and is now in the process of downwardly adjusting to the probable recession and lower earnings prospects. The cyclically adjusted price earnings ratio (CAPE/Shiller index) of the S&P 500 has tumbled from the breath taking level of 39 in December 2021 to 28 to date, which, though still high means it has lost 22 percent in value. Valuation on the NASDAQ had dropped a good 34 percent from its record high in November 2021 by the end of October. Portfolio shifts have also become more prevalent since bonds have been recording tangible yields again. The Russian bond market lost half its value in the course of 2022, the stock markets of emerging countries were down by one third, while valuations in the United States (S&P 500), Germany and Italy have fallen by a good quarter, in Europe overall and in France by 20 percent, in Shanghai by 15 percent and in Japan by eight percent. The price earnings ratio in the broad EuroStoxx600 index dropped from 20 to twelve in the course of the year. The price earnings ratio of the Nikkei has been at between twelve and 13 for the last eighteen months. Valuations in Turkey and Argentina have gone the other way, increasing by more than 50 percent.

Germany Italy France USA China Japan

Source: Macrobond

Stock market

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13000

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9000

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Euro area USA China Japan NASDAQ-100

Source: Macrobond

Japan bucking the trend

Although the Japanese economy has been through a slowdown, it is still set to grow above its potential growth rate next year (1.5 percent in 2023). In 2024, is forecast to grow at about its potential growth rate. To fend off the economic decline on the cards for the following year, the Japanese government announced a large scale investment package in education, digitalisation and climate protection in late October designed to stimulate the economy through to 2024. The consolidation prospects for Japan’s national budget remain uncertain as neither new income nor expenditure cuts are on the agenda.

The Japanese government has introduced several measures to provide marginal subsidies (volume of around 0.5 percent of GDP) for private households and enterprises to help with the high energy and food costs and has been able to throttle the drivers of price pressure and keep inflation under control. Wages are set to increase gradually and inflation is set to stabilise at around the two percent mark by 2024, but, unlike in Europe, this is considered desirable by the central bank and the government. These measures should be sufficient to keep real consumption expenditure pointing up. At the same time, the weak global economy is not providing much momentum for exports or corporate investment. Foreign trade should increase by almost two percent, as China’s economy is picking up and growth continues to be solid in the Asian developing and emerging countries. Investment activity is also expected to grow by almost three percent following a good ten percent drop between 2019 and 2022. The strong devaluation of the yen and the growing divide between US and yen key interest rates has prompted Japan’s central bank to intervene on the currency market. The tension is set to persist for a few quarters yet. The yen has not only depreciated by 25 percent against the dollar but has also dropped by 25 percent on a nominal, trade weighted basis and by 18 percent in real terms.

Global industrial production

Following the pandemic induced slump of 2021, the global industrial economy reached calmer waters this year. According to figures from the Netherlands Bureau for Economic Policy Analysis (CPB), in the

second quarter of 2022, global industrial production increased by 2.6 percent year on year, after recording a 4.4 percent rise in the first quarter. The pace of growth accelerated slightly in the first two months of the third quarter. As of August, industrial production was 3.5 percent higher than the same period last year.

Industrial activity is expected to lose steam over the further course of the year. The purchasing managers’ index for manufacturing dropped to 49.8 index points in September, the first time it has left expansionary territory in 26 months. The index continued to fall in October, no doubt partly due to the uncertainty surrounding the war in Ukraine. Global supply chain problems have eased up somewhat however, which could lead to a moderate recovery. For the year overall, an increase in global industrial production of just over three percent is within reach if current production levels are maintained.

Advanced economies:

Industrial

production*, Purchasing Managers Index

emerging economies advanced economies

2020 2021 2022

*Production index: two month average, after calendar and seasonal adjustments, in percent, year on year

Sources: Macrobond, Netherlands Bureau for Economic Policy Analysis, own calculations

Advanced economies: recovery faltering since the summer

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In the advanced economies industrial production increased by 2.8 percent in the first quarter of this year compared to the same period last year. Similar growth was recorded in the second quarter (up 2.4 percent) and the first two months of the third quarter. As of August, industrial production was 2.5 percent higher than in the same period last year. The trends in the different regions of the world were very divergent in the first eight months of the year. The group of other advanced economies recorded the highest growth in industrial production, 4.8 percent, followed by the US industry where growth was almost as high at 4.5 percent. While Japan’s industry saw production dip by one percent, industrial output in the other developed Asian countries grew by a robust 4.2 percent. In Europe, industrial production in the Euro area had only increased by a very modest 0.6 percent year on year as of August. Industrial activity in the United Kingdom contracted 2.5 percent over the same period.

Industrial activity in the advance economies is poised to slow down in the further course of the year. The purchasing managers’ index for manufacturing in this group of countries has fallen for eight months in a row. In September, it was barely above the expansion threshold at 50.1 index points before reaching a 27 month low by dropping to 48.8 index points in October. The sentiment indicators indicate

that we can expect production to stagnate in the fourth quarter. As a result, annual growth in 2022 for industrial production would be at slightly over two percent.

Advanced economies: Industrial production*, Purchasing Managers Index

60

55

50

45

40

35

15

5

-5

other advanced economies Euro area Japan USA

Purchasing Managers Index seasonally adjusted (left axis)

2019 2020 2021 2022

*Production index: two month average, after calendar and seasonal adjustments, in percent, year on year

Sources: Macrobond, Netherlands Bureau for Economic Policy Analysis (CPB)

Emerging countries

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25 30

Industrial production in the emerging countries recorded robust growth at the start of 2022, expanding 6.1 percent year on year. Covid restrictions in China and the outbreak of the war in Ukraine then put the brakes on industrial activity, pulling growth down to 2.8 percentage points in the second quarter. In the first two months of the third quarter, the pace of growth picked up again. As of August 2022, industrial production was up by 4.3 percent compared to the first eight months of the previous year. Fuelled by the sharp increases for fossil fuels, production in Africa and the Middle East recorded the highest growth for this period, climbing 8.8 percent. Industrial production also recorded above average growth in the Asian emerging countries excluding China (up 4.5 percent). Chinese industry has also regained its footing and expanded its output by 3.7 percent in the first eight months of the year. In Latin America, industrial production is set to be positive for the second year in a row, with growth in production at 3.3 percent for the first eight months of the year. The weakest performance among emerging countries was in the countries of Central and Eastern Europe, though industrial production here still managed to grow by 2.2 percent.

In recent years, the strongest growth momentum has always come from Chinese industry, but in 2022 this role seems to have been taken over by the industries of Africa and the Middle East and the remaining Asian emerging countries. The purchasing managers’ index for emerging countries has dropped three months in a row after reaching its high for the year so far in June. In September and

October, it even sank below the threshold of 50, at 49.4 index points and 49.8 index points respectively. Despite the slowdown anticipated for the fourth quarter, for 2022 overall, we expect industrial production in emerging countries to register growth of around four percent.

Emerging economies: Industrial production*, Purchasing Managers Index

55

50

45

40

35

Africa/Middle East Latin America

Central and Eastern Europe Asia (excluding China) China

Purchasing Managers Index seasonally adjusted (left axis)

*Production index: two month average, after calendar and seasonal adjustments, in percent, year on year

Sources: Macrobond, Netherlands Bureau for Economic Policy Analysis (CPB)

Global trade

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5

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60 2019 2020 2021 2022 -20

Russia’s war of aggression against Ukraine temporarily took momentum out of global trade. In March 2022, global trade decreased by 1.3 percent compared to the previous month and another 0.1 percent in April, according to figures from the Netherlands Bureau for Economic Policy Analysis (CPB). By May, trade had recovered and exceeded its pre war level. As of August, global trade had expanded by 4.4 percent compared to the same period last year.

The goods exports of emerging countries grew by 5.4 percent in the first eight months of the year compared to the same period last year. With an increase of 10.9 percent, exports from Africa and the Middle East grew the most, followed by the Asian emerging countries (excluding China), whose exports expanded by 8.8 percent. China’s exports increased by a below-average rate of 2.4 percent. Exports from Central and Eastern Europe nudged up a marginal 0.4 percent. Exports from Latin America recorded above average growth of 6.6 percent.

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-15

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advanced economies emerging economies

2018 2019 2020 2021 2022

Index: two month average, after calendar and seasonal adjustments, in percent, year on year

Source: Macrobond

The exports of advanced economies had increased by a total of 2.6 percent as of August, compared to the same period last year. In this group of countries, the largest driver of growth was the United States with an above average increase in its goods exports of 4.2 percent. Exports from the United Kingdom rose at a higher rate of 5.5 percent, but this was only due to the low base level following two years of decline and one year of stagnation in exports. The upward trend in Asia remained modest. Japan’s exports dipped by a slight 0.5 percent in the first eight months of the current year while the other Asian advanced economies countries only managed to up exports by a slim 1.1 percent. The Euro area exported 3.4 percent more goods than one year ago. Exports from the other advanced economies increased by an above average 3.5 percent.

The latest figures show trade activity stalling somewhat. In August 2022, global exports increased by only 0.4 percent compared to the previous month. While exports from advanced economies grew by 1.6 percent at last count, exports from emerging countries dropped 1.9 percent signifying a second consecutive fall. Even if trade activity stagnates for the rest of the year, global trade would grow by more than four percent this year overall.

USA

Economic development

After recovering from the slump in economic output caused by Covid 19, the Fed’s turnaround in interest rates, the tight labour market, China’s zero Covid strategy and the war in Ukraine are dampening are dampening growth this year. In the first two quarters of 2022, annualised US GDP shrank by 1.6 percent in the first quarter and 0.6 percent in the second quarter after price adjustment, according to figures from the Bureau of Economic Analysis (BEA). According to a preliminary BEA estimate, the US economy has turned around in the third quarter 2022, growing by 2.6 percent following price adjustment and in annualised terms. This surprisingly robust growth was brought about by higher exports and consumption expenditure as well as higher public expenditure (BEA 2022a).

World: Exports according to region of origin

US GDP growth, quarterly (annualised)

35.3 3.9 6.3 0.7 2.7 0.7 1.6 0.1

0

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-30

4.6 29.9

2.6 -40

Source: Bureau for Economic Analysis

In its September 2022 forecast, the OECD assumed low GDP growth of 1.6 percent in 2022 and 0.5 percent for 2023. Expectations have dimmed considerably compared to the first half of the year (OECD 2022). In October 2022, the International Monetary Fund (IMF) also assumed 1.6 percent growth in 2022 and one percent in 2023 (IMF 2022). We expect the economy to grow by 1.5 percent in real terms this year.

The level of unemployment in the United States is still very low. Despite an increase of 0.2 percentage points to 3.7 percent in October compared to the previous month (3.5 percent in September), the low level of unemployment, which has fluctuated between 3.5 and 3.7 percent since March 2022, shows that the current crisis has still not spilled over into the labour market. Despite the slight increase in the unemployment rate, the number of vacancies in October 2022 increased by 261,000 compared to the previous month. The largest growth in vacancies was in healthcare (up 53,000), followed by professional and technical services (up 43,000) and in manufacturing (up 32,000) (BLS 2022a). The pressure on wages therefore remains high and is driving inflation further. In a speech on 10 October 2022, Fed Vice Chair Lael Brainard suggested that companies that had great difficulty in finding skilled labour after the pandemic could be deciding to keep staff on longer even when demand fell, instead of dismissing them. The personal services sector still has over one million employees less than before the pandemic, which indicates that companies in this sector are still struggling to close this gap (Brainard 2022).

Inflation remains very high. According to the Bureau of Labor Statistics, the Consumer Price Index (All Urban Consumers, CPI U) rose by 8.2 percent in September compared to the same month last year (before seasonal adjustment). Over the summer months, inflation only increased marginally. The seasonally adjusted increase compared to the previous month was down to only 1.3 percent in June, 0 percent in July and 0.1 percent in August. The most recent figure shows a rise of 0.4 percent in September compared to August (BLS 2022b)

The steep inflation has also affected the sentiment of US consumers. After improving in August and September, the Consumer Confidence Index of the US Consumer Confidence Survey (a barometer of consumer sentiment) dropped from 107.8 in September to 102.5 points in October. Concerns about inflation are driven primarily by rising petrol and food costs. Vacation intentions also cooled down but intentions to purchase homes, automobiles, and major appliances all rose. Looking forward, the Conference Board anticipates a challenging Christmas season for retailers (The Conference Board 2022). After a 0.2 percent drop in July compared to the previous month, private consumption expenditure increased by 0.6 percent in both August and September (BEA 2022b). At the same time, the savings rate of private households (in percent of disposable income) gradually declined, going from 3.5 percent in July to 3.4 percent in August and 3.1 percent in September (BEA 2022c).

Foreign trade

Exports of goods and services grew each quarter over the year, while imports remained at the same level in the first and third quarter and fluctuated slightly in between. In the third quarter 2022, the United States exported goods and services to the value of 778 billion US dollars. That represents growth of just over two percent compared to the second quarter 2022. Imports in the third quarter 2022 totalled 988 billion US dollars, representing a three percent drop from their high second quarter level. Trade deficit (goods and services) was also lower than in the two previous quarters, amounting to around 209 billion US dollars in the third quarter (BEA 2022d).

Fiscal measures of the Biden administration

Following last year’s American Rescue Plan and the Infrastructure Investment and Jobs Act last year, the Democrats adopted another extensive package of expenditures in summer 2022. The volume of the Inflation Reduction Act (IRA) is lower than the originally envisaged Build Back Better Act, which was designed to be a core component of US President Biden’s domestic policy but did not get through the Senate in late 2021. The new package, which was adopted in the middle of August 2022 following a compromise between the party leadership and key centrist members of the Democrat Party, has a volume of around 433 billion US dollars, 369 billion of which are earmarked for climate protection. These investments include (Senate Democrats 2022a):

▪

27 billion US dollars for a Greenhouse Gas Reduction Fund to finance low emission and zero emission technologies together with private sector funding;

Two billion US dollars in grants to convert automobile factories to clean vehicle production; ▪ Ten billion US dollars in tax credits for investments in clean technology production facilities (solar plants, wind turbines, clean vehicles, etc.);

▪

▪

30 billion US dollars in grants and loan programmes for state and electricity suppliers to increase clean power generation (Senate Democrats 2022b).

According to Congressional Budget Office (CBO) estimates, the IRA could generate new revenues of up to 739 billion US dollars. Over the next ten years, the act could reduce the budget deficit by a total of around 110 billion US dollars (CBO 2022).

China: growth outlook

China’s economy grew by a surprising 3.9 percent in the third quarter. This represented a clear recovery compared to growth of 0.4 percent in the previous quarter. The year started off well with 4.3 percent growth in the first quarter but then started to falter.

Sentiment throughout the country has dropped due to the zero Covid strategy and the repeated lockdowns. The 20th Party Congress did not give any indication of a change in policy on this front. Compounding the situation are the harsh state interventions in the technology and real estate sectors together with measures to reduce emissions and contain financial risks, which are also keeping the lid on growth. Altogether, these measures have had a considerable impact on the investment climate for private enterprise and foreign investors. The Party Congress also clearly set the course for a permanent strengthening of the state economy.

The deteriorating prospects for the global economy are also increasing the pressure on China’s economy Russia’s war in Ukraine has sent inflation soaring worldwide and reduced purchasing power in China’s main export markets. Exports served as a stabilising factor for China’s growth during the pandemic so declining demand here increases the risks still further. Central banks, above all the US central bank, have responded to the situation with rapid interest rate hikes, which trigger capital outflows as investors seek safe havens, putting downward pressure on the Chinese currency.

So far, China’s political decision makers have targeted the supply side with their economic measures, mainly aiming to strengthen high tech production, promote innovation and increase infrastructure expenditure. The current measures are primarily geared towards the Communist Party’s long term strategic objectives of modernising the economy and reducing its technological dependency on the West. However, consumption and private investment will not improve without a fundamental change in policy The increasing economic uncertainty is making households and enterprises noticeably cautious about spending.

Without a fundamental policy turnaround, the country’s economic policy will increasingly frustrate the private sector and the middle classes. However, there are no signs of a return to a more pragmatic economic policy approach. Instead, further ideologically motivated measures and an expansion of state capitalism seem to be on the agenda. This will have a negative impact on the efficiency of capital allocation and considerably reduce China’s long term growth prospects.

The Chinese economy is therefore likely to post a disappointing performance in 2022, far below the already abandoned target growth of around 5.5 percent. In the first three quarters of the year, the Chinese economy expanded by three percent, which has prompted the large banks to downwardly revise their growth forecasts again for the year overall and for 2023.

Construction recovers while services remain weak

Construction activity posted the strongest recovery, rising 7.8 percent in the third quarter compared to the previous year. Manufacturing grew by four percent and services by 3.2 percent. It should be said, however, that a large proportion of this upward trend is due to the low base level of last year’s figures. In the third quarter 2021, for example, construction activity dropped 1.8 percent.

The low growth of the service sector continues to be a weak point in the economy and only improved marginally in the third quarter. IT related services, which have long been a major driver of growth in the service sector, grew by 7.9 percent year on year, after 7.6 percent growth in the second quarter. The sector is still far behind the growth of 21.7 percent seen in 2019 before the pandemic and the harsh interventions of the government in the Chinese technology sector.

The weak economy is also burdening the country’s public finances. Expenditure for healthcare services related to the implementation of the stringent Covid measures and to the growing costs of easing the pressure on the labour market is rising. The key sources of revenue are faltering. Revenue from corporate income tax rose 2.1 percent, its lowest growth in almost two years, while revenue from real estate sales was down 8.9 percent in the third quarter compared to the previous year.

Industrial activity remains a major driver of total GDP growth. In the third quarter, industrial value added grew by 4.8 percent compared to last year. Growth in the manufacturing sector was 4.1 percent on average which is its strongest quarterly performance since the second quarter 2021, buoyed by a 6.4 percent growth surge in September. The government’s focus on stimulating supply and measures to minimise supply chain disruptions seem to be paying off for the time being.

The high tech industries are a consistent bright spot and recorded particularly good results in September. Value added here no longer hit double digits, but was nonetheless 9.3 percent higher than in September 2021. In the third quarter, production growth in vehicle manufacturing averaged seven percent, in electrotechnology and mechanical engineering 14.4 percent and in electronic products 7.8 percent compared to the same period last year.

Confidence among manufacturers and service providers fell at the end of the third quarter. The Caixin purchasing managers’ index for manufacturing stood at 48.1 in September, and the PMI for services dropped from its high level of 55.5 in July to 49.3 in September.

Foreign trade and trade surpluses rise steeply

Exports remain an important pillar of the economy even though the pace of growth here slowed in the third quarter. The growth of exports in US dollars dropped from 17.9 percent at the end of the second quarter year on year to 5.7 percent in September. Despite the slower pace of growth, China still exported goods worth 322 billion US dollars in September, not far off the all time record of 340 billion US dollars posted in December 2021 and well above the pre pandemic level of 218 billion US dollars in September 2019.

Rising inflation and reduced growth prospects in key export markets have not yet had a tangible effect on the demand for Chinese goods. Exports to the EU increased by 16.9 percent in the first nine months of 2022 while exports to the United States and the ASEAN region rose by 8.9 percent and 20.6 percent respectively in the same period.

Vehicle exports hit a new high as Chinese enterprises strive for global expansion, particularly in electric vehicles (EV). In the first nine months of 2022, auto exports soared 64.6 percent to a new record level. China has now overtaken Germany as the world’s second largest vehicle exporter after Japan.

Imports recorded a minimal growth of 0.3 percent in September year on year and growth of 4.1 percent in the first nine months of the year. Apart from raw materials, China’s demand for goods produced abroad is low. Auto imports dipped 0.6 percent and imports of machinery fell 12.3 percent.

The discrepancy between exports and imports has led to an ever increasing trade gap. China’s trade surplus reached 101.3 billion US dollars in July which is a record monthly result. In September, it went down to 84.6 billion dollars, but this is still a record level.

China: foreign trade*

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100

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350 2018 2019 2020 2021 2022

Trade surpluses Exports Imports

* in billions US dollar

Source: Macrobond

Economic support measures needed

The government’s economic measures, including cheaper loans, are fuelling investment in state owned enterprises (SOE). These picked up momentum in the third quarter, rising by 10.6 percent by the end of the quarter compared with an increase of 9.2 percent at the end of the second quarter.

Infrastructure investment gradually gathered pace after the government announced an infrastructure plan in July with a price tag of 6.8 trillion Chinese yuan. Infrastructure investment rose 8.6 percent in the first nine months of the year, reaching its highest level this year so far. However, the impact of higher infrastructure investment cannot offset stagnating real estate investment.

Consumer prices still moderate while producer prices return to normal

Consumer inflation accelerated in the third quarter and reached 2.8 percent in September year on year, the highest monthly increase since April 2020. But this is still only marginally higher than the five year average of two percent. Annual inflation is below the annual target of three percent. Rising prices are not a major issue for the country’s political decision makers as they are planning further economic measures.

Since the beginning of the Russian war in Ukraine, China has also seen energy prices rise. Prices peaked in the second quarter before dropping again in the third quarter. The monthly increase in fuel

prices for vehicles was down from 32.8 percent in June year on year to 19 percent in September, and energy costs for industry had increased by 29.4 percent in June year on year before dropping to 14.3 percent in September.

The producer price index (PPI) has been on a downward trend for eleven months and was 0.9 percent down in September year on year. The decrease in prices is due to the globally falling commodity and energy prices as well as the ongoing low demand in the economy. The economic measures have so far not pushed prices up in the construction sector.

Labour market is stable but youth unemployment remains problematic

The persistently weak level of consumption in the services sector and in retail as well as the slowdown in the real estate and technology sectors are having a tangible impact on the labour market. The manufacturing sector presents a more mixed picture in which the automotive sector, mechanical engineering and electronics are the shining stars that together created more than one million new jobs up to 2022.

The number of newly created urban jobs is set to reach the target for the year of eleven million after already passing the ten million mark at the end of the third quarter. 2022 is nonetheless still likely to be the worst year for job creation since the start of the pandemic in 2020.

Unemployment in the cities is at a stable level, coming in at 5.5 percent at the end of September, a slight increase on the August level of 5.3 percent. Youth unemployment, however, reached a new all time high of 19.9 percent in August. This had dropped to 17.5 percent by the end of the third quarter but is still high, due to by the record number of new university graduates entering the labour market.

Retailers under pressure

Until the end of September, around 30 million people were still affected by some form of lockdown. The unpredictable nature of the measures and the lack of an exit strategy are preventing any significant improvements in retail sales. Sentiment is at a record low and consumers are opting to save rather than spend.

Retail sales did continue to grow in the third quarter but are still very vulnerable. In August, growth reached 5.4 percent, its highest rate since January, but then dropped to 2.5 percent in September. Consumers’ fear of being affected by a lockdown is reducing spending on hotels and restaurants in particular.

Local governments are dispensing vouchers and subsidies to help kick start consumption. But consumption is not the top priority of the state’s economic agenda which continues to focus on manufacturing and investment.

One of the few bright spots was the recovery of auto sales, propelled by state incentives including subsidies for electric vehicles. Auto sales increased by 13.2 percent in the third quarter compared to the same period last year.

Economy in EU and Europe still resilient but recessions here and there are almost unavoidable

The economic situation in the EU and in the Euro area is marked by the large gap between the current situation, which is still fairly resilient, and the firm expectation that a hefty downturn is on the horizon For this year, growth in the Euro area and in the EU is still forecast to reach a good result of around three percent in real terms before dropping to almost zero next year.

In the first two quarters of the current year, economic activity in the Euro area was still growing at a robust pace (up 0.6 percent and 0.8 percent year on year) and even managed to remain above zero in the third quarter (up 0.2 percent year on year) despite the energy price and inflation shock. Among the major economies, Italy expanded the most, growing 0.5 percent, followed by Germany (up 0.3 percent), France and Spain (both up 0.2 percent). The catch up demand following the pandemic brought the southern European countries a good tourist season in the summer with the Recovery and Resilience Fund of the Next Generation EU package also propping up investment.

Growth to be very low in 2023

All analysts agree that the prospects of the Euro area for the fourth quarter and the next year are much less rosy Back in July, the European Commission was forecasting real growth rates of more than one percent and even in September, the ECB regarded growth of almost one percent to be within reach (0.9 percent), but the OECD, the IMF and European peak association (BusinessEurope 2022) have downwardly revised growth prospects to between 0.25 and 0.5 percent growth. We expect real private consumption expenditure and state consumption in the Euro area to stagnate and marginal growth in fixed gross capital formation.

Investment activity will suffer and remain feeble

The cost and inflation shock, subdued demand prospects in North America and the continued uncertainty surrounding the Ukraine war will, we believe, sharply decrease corporate investment activity. The OECD still forecasts slight growth in fixed gross capital formation of just under one percent. The full impact of the monetary measures will also have reached corporate financing towards the end of 2023. Furthermore, many companies are still having a hard time passing on the increased purchase prices (above all for energy) to their product prices. While purchase prices have risen considerably (by a good 40 percent), many industries are not able to transfer much of the cost pressure onto product and final consumer prices due to contractual provisions or international competition. This price pass through will take some time yet as there is a limit to how much of these costs can be absorbed by squeezing profit margins and insolvency risks have risen drastically in many energy intensive industries. All these factors are keeping investment activity down. The construction sector is already feeling the brunt of the more stringent financing conditions and is facing a plunge from its very robust current level, which will also greatly restrain construction investment. Public investment, on the other hand, is set to continue for many countries with the EU Recovery and Resilience plans, which will help prop up investment levels.

Private households must absorb cost shock and are reducing spending

Real consumption expenditure is being curbed by the cost shock and the loss of purchasing power in real terms. Consumer confidence in the Euro area has tumbled since summer 2021. We do not expect

this to be compensated by reduced savings rates as these have already declined steeply and households are increasingly limiting their spending instead. Real consumption expenditure will thus trend sideways.

Heterogeneous trends among member states

Prospects are bleak for most of the major economies in the Euro area: Germany is set to undergo a marked slump in economic activity. France and Italy are likely to stagnate or record moderate growth at best (OECD 2022, BusinessEurope 2022, Confindustria 2022). The peripheral countries of Europe are in slightly better shape. Spain’s economy is slightly less affected by the energy crisis and should still manage growth of 1.5 percent. Most Central and Eastern European countries are likely to remain on a low growth path, with the exception of Hungary, which is heading for a deep recession.

France facing weak year in 2023

France has not been quite as badly impacted by the price shock as Germany and Italy on account of its economic structure and energy mix. It also introduced price based support measures promptly and recently bolstered these with more targeted measures for households and enterprises. These steps have kept inflation to below average rates and have secured solid growth for this year of around 2.5 percent. The reduction in the purchasing power of private households and the cost burden for enterprises will nonetheless keep real consumption expenditure and investment very low next year. Foreign trade will not deliver any real momentum either.

Stagnation in Italy

Italy has been hit very hard by the energy shock due to its economic and energy structure, which is very similar to Germany’s. Mario Draghi’s government rapidly initiated support measures to the volume of three percent of GDP and managed to swiftly organise alternative energy supplies. The large scale Recovery and Resilience Plan for Italy has strongly kick started public investment in the country (by a good one percentage point of economic output) although some elements of the plan are running behind schedule. Inflationary pressure in Italy is nonetheless high and the typical effects on consumption and private investment expenditure, particularly those of energy intensive companies, are already broadly evident. The energy costs for companies have more than doubled this year (Confindustria 2022). Industrial production and retail sales have been in steep decline since the summer. At least summer tourism boomed. Due to the high level of public debt and the greatly increased spread to Germany, loans for Italian companies and households have become a lot more expensive, despite the scope of the ECB to contain speculative attacks with the Transmission Protection Instrument. This increase in the cost of credit is not based on a deterioration of Italy’s fiscal indicators. On the contrary, the support measures are being financed primarily by the additional revenue from increased inflation, and public debt is set to fall by almost five percentage points of economic output due to inflation and will not rise in 2023. Whether and to what extent the Meloni government will switch to a more expansionary fiscal course remains to be seen. The budget submitted to Brussels sets out moderate increases in expenditure, so policy scope is limited. Inflation will keep demand low next year, while foreign trade is likely to have very little effect on growth. The export of goods and services has increased by more than ten percent this year. A repeat performance is out of the question for next year, with growth in exports forecast at just under two percent for 2023.

Germany

The technical recession hovering over Germany at the start of the year has been averted for the time being. This is mainly thanks to the robust recovery of the service industries that had been severely impacted by the Covid restriction measures one year ago. Manufacturing, on the other hand, is still struggling with the consequences of the pandemic. Material and supply bottlenecks intensified in the summer months and it is still unclear whether and when this situation will ease. The war in Ukraine is likely to further prolong Germany’s supply chain problems.

German foreign trade has suffered considerably from supply bottlenecks. This was the main reason why net exports failed to contribute to economic growth in the first quarter. The lockdowns in China, though lifted now, were still having a tangible effect on foreign trade over the summer. The increased uncertainty caused by the outbreak of the war in Ukraine is additionally weighing down trade. Due to the weak results of the first six months of the year, the growth in export of goods and services for 2022 as a whole is unlikely to be more than 2.5 percent in real terms. Lower exports will also reduce the import of intermediates. However, the sharp increase in prices for fuel and non-fuel commodities has considerably worsened the terms of trade and is pushing up import bills steeply. With travel picking up again, the import of services also increased robustly this year. All in all, imports are set to rise by 6.5 percent following price adjustment, thereby far outperforming exports.

The lifting of restrictions to stem the pandemic boosted private consumption at the beginning of the year. High contact services benefited particularly in the first quarter. Rising employment, the support packages to compensate the higher energy prices, and the pension adjustment that came into effect in the middle of the year all served to stabilise private consumer demand. Even if only a quarter of the surplus savings from the pandemic flow into consumption expenditure this would translate into growth of more than two percentage points in private consumption alone. Despite the current high price increases that will burden consumption in real terms, private consumption expenditure is on track to grow by 3.5 percent this year. Public consumption expenditure is also set to increase again this year due to spending to support refugees from Ukraine and on the federal government’s aid measures to compensate citizens for burdens related to the war. We expect growth here of around 2.5 percent.

In spite of the high investments needed for the digital and energy transition, growth in investment this year is likely to be restrained. The biggest factor curbing investment is the heightened uncertainty surrounding the war in Ukraine. In view of the current material bottlenecks, additional investment will not be able to help expand production. The contribution to growth from investment in plant and equipment is therefore just 0.5 percent. In construction investment we expect to see a drop of 1.5 percent this year, with growth increasingly hampered by the severe shortage of materials. Although the planned residential construction projects should not yet be affected by the rise in interest rates this year, price increases are weighing down investment in public construction and the higher value of authorised commercial construction is only due to the increase in prices and is actually negative in real terms. Investment in other assets (software, research and development) has already increased by one percent since the beginning of the year. It should continue to recover in the further course of the year and reach growth of two percent compared to last year. All in all, gross domestic product this year is set to rise by just over one percent year on year in real terms.

Sources

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Bureau of Economic Analysis (2022a). News Release. Gross Domestic Product, Third Quarter 2022 (Advance Estimate) 27 October Washington, D.C. (2022b). Personal Income and Outlays, September 2022. 22 October. Washington, D.C. (2022c). National Income and Product Accounts. Table 2.6. Personal Income and Its Disposition, Monthly. 27 May. Washington, D.C. (2022d). Table 1. U.S. International Trade in Goods and Services. 3 November. Washington, D.C.

Bureau of Labor Statistics (2022a). Employment Situation Summary. 4 November Washington, D.C. (2022b). Consumer Price Index May 2022. Washington, D.C.

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Deutsche Bank Research (2022). The House View. September. Frankfurt/M.

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Federal Reserve Board of Governors (2022a). Federal Reserve issues FOMC statement. Press release 2 November Washington, D.C.. (2022b). Summary of Economic Projections. 21 September. Washington, D.C..

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Obstfeld, Maurice (2022). Uncoordinated monetary policies risk a historic global slowdown. Peterson Institute for International Economics. Washington, D.C.. Blog. 12 September.

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Senate Democrats (2022a). Summary: The Inflation Reduction Act of 2022. Washington, D.C. --(2022b). Summary of the Energy Security and Climate Change Investments in the Inflation Reduction Act of 2022. Washington, D.C.

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Imprint

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Authors

Dr. Klaus Günter Deutsch

T: +49 30 2028 1591 k.deutsch@bdi.eu

Stefan Gätzner BDI Vertretung, Peking

T: +86 1085 322862 s.gaetzner@bdi.eu

Julia Howald

T.: +49 30 2028 1483 j.howald@bdi.eu

Thomas Hüne T: +49 30 2028 1592 t.huene@bdi.eu

Anna Kantrup T.: +49 30 2028 1526 a.kantrup@bdi.eu

Wolfgang Krieger BDI Vertretung, Peking T: +86 1085 325421 w.krieger@bdi.eu

Editorial / Graphics

Marta Gancarek

T: +49 30 2028 1588 m.gancarek@bdi.eu

This report is a translation based on „Transatlantische Schwächeperiode | Der Krieg führt Europa und die USA in schweres Fahrwasser“, as of 14 November 2022.