Fitch: The shock of inflation could threaten the economy with a recession

Her Eleftherias Kourtali

The shock of inflation could begin to threaten the global economic outlook this year, Fitch Ratings says in a new report. A scenario where US inflation remains very high in the second half of 2022 and medium-term inflation expectations are rising is reasonable and could cause the Fed to tighten its policy much more sharply than expected.

According to the house, core inflation is expected to fall widely in the US and Europe in the second half of 2022, as shortages of consumer goods are reduced, restrictions imposed by the pandemic on labor supply weaken and growth rates normalize. This will allow central banks to gradually normalize monetary policy, with limited implications for growth.

Fitch expects the Fed to raise interest rates by 100 basis points in 2022 and by 100 basis points further in 2023, the Bank of England will raise interest rates by 75 basis points. further this year and by 50 bp. in 2023, with the ECB raising interest rates by 20 basis points. next year and not at all this year.

However, recent data on inflation were higher than expected and price prospects are uncertain. Inflation is a dynamic process and can be self-reinforcing, as the house typically notes. Various factors could keep core inflation high throughout 2022, and the global energy price shocks associated with the Russia-Ukraine crisis are exacerbating the risks.

If inflation remains high and inflation expectations rise, the Fed and the Bank of England could have no choice but to quickly move interest rates to neutral or restrictive levels. This could result in the Fed Funds raising interest rates to 3% by the end of this year.

A sharper adjustment could have a major impact on GDP, the firm warns, including tighter credit conditions and a sharp rise in US long-term bond yields. US GDP growth could fall to 0.5% or lower in 2023 in such a scenario, compared to Fitch’s baseline forecast of 1.9%.

“We looked at a scenario with faster Fed interest rate hikes, faster balance sheet cuts and sharp credit crunch, with a 15% correction in stock markets and higher bond yields. The results suggest a shock to US growth by about 1% in 2022 and 1.5% to 2% in 2023. Based on our latest growth estimates of 3.7% in 2022 and 1.9% in 2023 in the US, this scenario saw the US economy approaching in recession next year “”, as Fitch points out.

In general, as the house points out, while central banks will be aware of the negative effects on the real economy, their inflation mandates would require them to be tolerant of slowing activity and rising unemployment. Restoring monetary stability would be a priority in such a case and there is likely to be a short-term recession or slowdown as a “necessary cost” to ensure a more resilient economy and labor market in the medium to long term.

The risk of a sharper policy adjustment by the ECB is lower, but if inflation in the eurozone remains high, quantitative easing could end and interest rates could rise this year.

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