1.0 The Front Pages

Global outlook increasingly gloomy and uncertain

Across the world, economies are facing an increasingly gloomy and uncertain outlook as they recover from their COVID-19 hangover and feel the impacts of the ongoing war in Ukraine, which continues to put pressure on food and energy prices. 

In the Autumn BEV, we reported that in its April 2022 World Economic Outlook, the International Monetary Fund (IMF) downgraded its global growth expectations for 2022 to 3.6 percent. With growth expected to stall across the US, Europe, and China, the IMF has dropped its expectations further to 3.2 percent. The IMF’s global outlook for 2023 sees growth fall further to 2.9 percent. The World Bank is more pessimistic, expecting global growth to fall to 2.9 percent this year.

Source: OECD, World Bank, IMF

The risks remain overwhelmingly tilted to the downside with disruptions to energy supplies, inflation, and tighter monetary policy expected to send the global economy into a recession. A recent World Economic Forum survey found that risks associated with social cohesion, mental health, and the cost of living have all increased since the onset of COVID-19.

Domestically, the arrival of warmer weather and the return of international tourism is a bright spot on the horizon. In the June 2022 quarter, GDP increased by a higher-than-expected 1.7 percent. The service sector has led the way in aiding a bounce back from last quarter’s negative growth. A rebound in international visitor numbers and fewer mobility restrictions domestically have led to output increases in the transport, arts and recreation, and retail trade and accommodation sectors. Looking to 2023, the summer season will bring more international visitors, and a definitive end to COVID-19 containment measures will continue to support service sector growth. On the flip side, tighter monetary conditions will weigh on households over the medium-term.

Inflation continues to drive up prices

Inflation, and the pressure it is putting on the cost of living, continues to be front of mind for many households. The consumers price index (CPI) increased 7.3 percent in the year to June 2022. This increase is the largest annual movement since a 7.6 percent increase in June 1990 that occurred shortly after the introduction of the Reserve Bank of New Zealand Act 1989. The Act, which came into effect in February 1990, targeted the high inflation from the previous decade and was aimed at maintaining stability in the general level of prices over the medium-term.

Aotearoa New Zealand is not alone as it tackles inflation. In their most recent inflation announcements, the countries we like to compare ourselves to all saw inflation spike. In Canada, inflation hit a 39-year high, increasing by over eight percent, and in the United Kingdom (UK), it reached 10 percent. Australia’s annual inflation for the year to June 2022 was 6.1 percent, and is expected to increase to almost eight percent by the December 2022 quarter.

However, there are global signs that inflationary pressures may be easing for some countries. In the United States of America (USA), inflation peaked at 9.1 percent in the year to June. The following month it fell to 8.5 percent, and by August 2022 it had fallen to 8.3 percent, as oil prices began to fall. 

Tackling inflation will have consequences elsewhere

Since the late 1980s, New Zealand has used monetary policy to achieve low and stable inflation. The Reserve Bank of New Zealand’s (RBNZ) mandate requires it to keep inflation between one percent and three percent, on average, over the medium-term, with a focus on keeping future average inflation near the two percent target midpoint. Since 1999 the primary tool RBNZ uses to control inflation is the Official Cash Rate (OCR). 

In 2018, an amendment to the Reserve Bank of New Zealand Act 1989 added an additional mandate – supporting maximum sustainable employment (or full employment). Maximum sustainable employment is interpreted as the level of employment at which the job market is tight, but not so tight that inflation is rising out of control. Treasury forecasts almost always have unemployment moving to four percent in the long-term, indicating this is the level of maximum sustainable employment. With unemployment at just 3.3 percent and inflation at its highest level since the OCR was introduced, RBNZ is likely to continue increasing the OCR, as they seek to slow demand sufficiently to meet their employment and inflation objectives. 

The retail banks, including Westpac, ANZ, and ASB, expect that RBNZ will increase the OCR to four percent before the end of the year, and that a cut will not occur until 2024. In the medium-term, RBNZ anticipates rising interest rates will reduce domestic demand, supply constraints will ease, and oil prices will fall. This combination will cause inflation to return to its two percent midpoint target in 2025. However, this will also require a higher unemployment rate, which RBNZ forecasts could go up to five percent by 2025. 

Consumer confidence remains low

In autumn, we noted that businesses and consumers had become distinctly more pessimistic during the past six months and that expectations about general business conditions had fallen towards the record low levels seen when COVID-19 first arrived in New Zealand. This trend has continued over winter and over the medium-term, higher interest rates, lower consumer confidence, and falling house prices are expected to contribute to weaker economic growth. 

The June 2022 Westpac McDermott Miller Consumer Confidence Index revealed consumer confidence had fallen to a record low, as household budgets have been stretched by higher mortgage rates and increases in living costs. Weak consumer confidence continues to weigh on spending appetites. 

Respondents to the ANZ Roy Morgan Consumer Confidence survey for August 2022 were slightly more optimistic, but overall sentiment remained low. Perceptions of current personal financial situations fell to a fresh low this cycle. The proportion of households that think it’s a bad time to buy a major household item increased slightly but remains near all-time lows. Meanwhile, consumers are spending less on services and general retail. 

House prices expected to fall further

House prices have fallen by 7.9 percent since peaking in November 2021. However, housing remains unaffordable in most regions. Prices are projected to continue to decline throughout 2022 and 2023. RBNZ is predicting house prices could fall up to 20 percent from the peak, as higher interest rates make it harder for new buyers to meet repayment requirements, and investor demand falls as they no longer see the same level of capital gains or are able to make interest deductions.

However, with such a significant proportion of New Zealand’s wealth concentrated in housing, and consumer confidence already near record lows, it is unlikely the government will let house prices fall too far for fear of the reverse-wealth effect gripping the economy. The wealth effect describes homeowners’ propensity to feel richer when house prices rise so spend more, therefore when house prices fall the opposite occurs.

As shown in the forecasts at the end of this Birds Eye View, we are expecting the economy to face difficult times over the medium-term with inflation leading to higher interest rates, reduced consumer spending on non-essential items, and increasing unemployment.
 

2.0 Special feature: Inequality and well-being in Aotearoa New Zealand

The unequal distribution of resources and opportunities has been a feature of societies since the dawn of human civilisation. The existence and impacts of inequality have been widely studied and debated through various lenses, such as economics, philosophy, and justice. Inequality manifests in many interrelated forms. It can mean unequal access to income, wealth, education, health, technology, and support networks. 

New economic thinking is increasingly distancing itself from a GDP-only approach. Wellbeing outcomes are now at the heart of many contemporary frameworks guiding socio-economic policy decisions. For example, in Aotearoa New Zealand, the Living Standards Framework (LSF) developed by the Treasury hopes to guide policymakers to consider wider distributional impacts.

Our perceptions of inequality

OECD research has found that nearly 75 percent of New Zealanders agree or strongly agree that income differences between high and low earners are too great. Just eight percent of people believe that the current levels of income differences are acceptable.

Despite the generally high concern for inequality, over 82 percent do not think that parental wealth or education are important determinants of individual success. In other words, as a society we believe that hard work gets you further ahead in life than generational wealth.

Detailed research on intergenerational mobility in Aotearoa New Zealand is virtually non-existent. So it is impossible to know whether the current policy tools facilitate better outcomes for children compared to their parents.

How unequal is New Zealand?

There are many ways to measure inequality. Traditionally, indicators that measure the distribution of income and wealth between different population groups have been most widely used.

The Gini coefficient, which measures inequality across the entire society, is the most commonly used indicator.

After taxes and benefit transfers have been accounted for, Aotearoa New Zealand falls roughly towards the middle of the pack when it comes to income equality within the OECD. We are more equal than major economies like the USA, UK, and Japan. But other countries that have high standards of living, such as Denmark, Canada, and Germany, are more egalitarian.

Redistributive tools, such as tax and benefit transfers, play a huge role in reducing income inequality, if executed properly. Fiscal measures targeted towards improving access to education, health, and technology can also improve intergenerational mobility. 

To understand if we are on the right track to achieving parity, it is important to investigate how current rates of inequality compare to historical rates. The Gini coefficient has fallen every year since 2017, indicating a shift to a more equal income distribution in recent years. However, inequality is still high compared to what it was in the 1980s. In 1985, the Gini coefficient for Aotearoa New Zealand was just 0.27. By 2000 this had climbed to 0.34.

It is also useful to see how wealth is distributed amongst the population. The distribution of wealth is generally much more unequal than income. This is because, unlike income, wealth is accumulated over time and can be transferred between generations. 

In Aotearoa New Zealand, the top 10 percent of households hold over half of the country’s total household net worth. This share has remained stable since at least 2015. During the same period, the share of total household wealth held by the top one percent of households fell slightly. 

There are large disparities in the distribution of wealth by ethnicity. European individuals have the highest median net worth, followed by those of Asian ethnicity. The median net worth of Māori and Pacific Peoples is just a fraction of that of Europeans. 

Between 2015 and 2021, median net worth for all individuals went up by 27.4 percent, reflecting a rise in property values. During this period, the median net worth of European individuals was up by 35 percent. For Māori, the increase was 91 percent, and for Asians, 87.5 percent. 
 

The indicators above paint a high-level picture of inequality in Aotearoa New Zealand from the perspective of the distribution of economic resources. However, they do not consider quality of life or general wellbeing. It can be argued that the goal of achieving higher equality in the distribution of economic resources is to maximise wellbeing, and income and wealth alone do not offer a full perspective on the multidimensional nature of wellbeing.

Wellbeing outcomes

One of the most useful sources of data to assess how income inequality affects whānau in Aotearoa New Zealand is the General Social Survey (GSS). What makes this data particularly useful is that it draws information about how people feel about their lives (subjective wellbeing). Household and individual income is captured along with a range of wellbeing aspects, such as housing quality, physical health, safety, mental health, and work life balance. The GSS has been conducted in 2014, 2016, 2018, and 2021. 

A good indicator of healthy overall wellbeing is when someone has:

• Excellent or very good health 
• More than enough or enough money to meet every-day needs
• Not felt lonely in the last four weeks 
• Their home is not cold, damp, or mouldy.

Respondents that reported none of the above four outcomes on the 2021 survey possessed a mean rating of six out of ten on overall subjective wellbeing. Respondents who reported all four outcomes had a mean score of 8.6 out of 10. 

The percentage of respondents possessing few to none of the key aspects of wellbeing rises as household incomes decrease. As incomes rise, so does the likelihood of possessing all four key aspects of wellbeing. We can see the correlation in the following figure. 

The primary tool that the Treasury uses to consider the impacts on wellbeing when funding policy is the LSF. This was updated in 2021 to better reflect the perspectives of Māori and Pacific communities, to capture child wellbeing, the role of culture, to incorporate the role of institutions and governance, and the role of collective wellbeing on communities. 

The LSF, which was originally adapted from the OECD wellbeing framework, previously viewed wellbeing from what some would call an “economist’s” view of the world, where there was a simple split between “stocks” and “flows” of wellbeing: capitals (like houses) represented future wellbeing and domains (like income) represented current wellbeing. The 2021 update of the LSF aimed to capture the stocks and flows of wellbeing throughout every level of society, from the individual, community, and institutional level. 

At the individual level, knowledge, skills, and financial resources are personal stocks that can contribute towards the wellbeing of that individual and their community. These resources can then lead to determining the potential of future wellbeing for individuals and groups through experiences and actions. However, these resources aren’t fixed, and can deteriorate or accumulate over time. From the perspective of the whole economy, these activities and experiences form different kinds of wealth, which can then provide an indication of long-term sustainability. 

Looking at multidimensional wellbeing combined from 2014 to 2018, we can see unequal outcomes are not purely determined by income. The figure below plots the percent of respondents reporting high wellbeing by gender. While female and total respondents rated similarly in high subjective wellbeing (34 and 33 percent respectively), there were considerable differences in the safety and wealth domains: only 25 percent of women reported high levels of safety compared to 40 percent of the total population; and 24 percent of women reported high levels of wealth compared to 33 percent of the total population. 

Ethnicity also has a part to play – all ethnicities scored closely (within one to two percentage points of 30 percent) on high subjective wellbeing, but that was where similarities ended. Arranging the data by rates of low wellbeing by ethnicity reveals startling disparities.  

Māori respondents reported high rates of low wellbeing across all dimensions, reporting the highest rates of low wellbeing in engagement and voice, safety, knowledge and skills, health, and family and friends. Respondents who identified as Pacific reported the highest rates of low wellbeing largely in housing and income. Respondents who identified as Asian reported the highest rates of low wellbeing in cultural capability and belonging, but were the least likely to report low safety, low knowledge and skills, and low engagement and voice. 

Another aspect of inequality is the impact on sole parents in Aotearoa New Zealand. 

Sole parents reported notably higher rates of low wellbeing across the board when compared to the rest of the population (couple without children, with children, and not in a family nucleus). Where subjective overall wellbeing generally tends to be close across population groups, sole parents reported glaringly high rates of low subjective wellbeing. Unfortunately, one of the most unequal lives to live in Aotearoa New Zealand is that of a single parent. 

The evidence from overseas and Aotearoa New Zealand shows that inequality is a complex issue that manifests in different ways across different communities. Income plays a large role, but just addressing income inequality is not a silver bullet for the whole problem. There may always be winners and losers in income and net wealth, but having low income should not bar people, families, and communities from living fulfilling and happy lives. 

3.0 People resources

The bald facts are:

• There were 81,500 more full-time employees in June 2022 than June 2021 
• The working age population and labour force was larger than in winter last year 
• Unemployment continues to remain low.

The labour market

The labour market has shown a relatively healthy outlook over the winter period. The labour force has grown, and unemployment remains low, which means more people entering the workforce are able to find jobs. Underutilisation has also remained relatively stable, at historical lows, over the quarter. All the signs point to an increasingly tight labour market. With net migration still in the red, there are no signs of respite for businesses strapped for workers.

What this data masks, however, is the high cost of living, which might be pushing people to work more hours. This is observed with full-time employment capturing the rise in the workforce, and a reduction in the number of part-time workers compared to last year. This is due to the fact part-time work is unlikely to provide enough income to live comfortably in New Zealand. 

4.0 Capital resources

The bald facts are:

• Building consents for new houses continued to rise over the winter quarter 
• The volume of building work has remained flat, despite the increase in consents
• Business lending rates are increasing.

Investment and building activity

The appetite for new homes continues to climb. There were 50,586 consents issued for new homes over the June 2022 quarter. 

The West Coast showed the largest growth by far (67 percent), compared to the same quarter last year. Gisborne followed at 37 percent more residential building consents, then Canterbury at 33 percent. Taranaki, Tasman, Hawkes Bay, Bay of Plenty, and Nelson all had less residential building consents issued this June quarter than last year’s June quarter. 

The value of building work completed and in progress did not exhibit the same growth as seen in consents issued over the winter period. Residential building work was hovering around $8 billion for a year, and non-residential work completed has not seen a significant departure from $4.7 billion since September 2021. 

There is major work underway by the Commerce Commission and Ministry for Business, Innovation and Employment (MBIE) to reform the building and construction sector. The building pipeline still does not match the capacity of the industry to deliver the work. Shortages in skills and materials have made headlines frequently this year, and the continued rise of consents issued suggests further delays are on the horizon if builders and suppliers cannot keep up. 

The money market has observed a rise in interest rates across the board. Unfortunately, for those looking to enter the housing market, average floating mortgage rates have climbed up from comfortable lows of 4.37 percent in June last year to 5.85 percent in June this year. 
The cost of business capital has also increased, with the business base lending rate averaging 9.48 percent for the 2022 June quarter. This is the highest the rate has been since the 2015 December quarter average of 9.52 percent. 

5.0 Home base

The bald facts are:

• Inflation was 7.3 percent during the June 2022 year 
• Local government operating deficits have decreased.

Government finances

The statistics for local authority financial performance for the March 2022 quarter was published in June. The seasonally adjusted figures showed that both council costs and revenue have been steadily increasing. 

Employee and purchase costs increased by six percent and 7.4 percent from March 2021 figures. In turn, revenue has also increased, largely attributed to rates increases across the board, which were on average 8.6 percent higher than rates last year. Spending did not grow as fast as revenue, so the overall operating deficit for local authorities decreased to $215 million, from $290 million in the previous quarter. 

Inflation

The annual inflation increase for the June 2022 year was 7.3 percent. The increase encompassed the cost of tradable goods increasing by 8.7 percent, reflecting high global inflation; and the cost of non-tradable goods increasing by 6.3 percent, showing increasing domestic pressures.

The highest driver of the CPI increase was the increase in the cost of home ownership, which went up by 18.3 percent compared to the same quarter last year. 

The cost of private transport supplies and services increased by 24.6 percent, and the cost of grocery food increased by 7.1 percent. 
Weakly combating cost of living increases was reductions in the price of audio-visual and computing equipment, credit services, and passenger transport services. 

Retail

The number of transactions slumped down to levels observed in the early COVID-19 days of winter 2020. Similarly, the total value of retail sales flattened out. The only goods people were purchasing more of was fuel and consumables, for both the June 2022 quarter and the year to June 2022. The biggest loser for the year has been hospitality, which observed a 13 percent drop in value purchased by consumers. 

What these numbers suggest is that outside of the necessities, people are purchasing less goods to combat the cost of living. People are not eating out like they once did, and are putting off purchasing new clothes and cars. 

This is also reflected in the steady climb of core retail sales values per quarter, which hardly skipped a beat following COVID-19 containment measures. It is clear the winners of the cost of living crisis continues to be retailers of core essentials such as supermarkets. 

6.0 Abroad and beyond

The bald facts are:

• Crude oil imports have screeched to a halt 
• The volume of petrol imported decreased last quarter, but the total value increased
• New Zealand dairy and meat continue to fetch high prices in overseas markets.

Trade

The total value of imports continued to increase over the June 2022 quarter. This is despite the dramatic drop in crude oil imports, where the total value equalled just $9,000. This dramatic drop was due to the closure of the Marsden Point oil refinery this April. 

Overall, the volume of imports has remained largely the same for food, machinery, textiles, and plastics. The volume of petrol and products decreased by nine percent from the same quarter last year. The price paid for these goods increased, resulting in the sustained climb observed in the figure below. 

For the most part, New Zealand’s exports continued to perform well in overseas markets. Export receipts for dairy, meat, merchandise, mechanical machinery, aluminium, and kiwifruit all exhibited growth over the June 2022 quarter. 

Dairy and meat producers were able to export less product for more profit due the continued rise of prices overseas. Forestry export receipts decreased due to flattening timber prices coupled with reduced exported timber volumes. 

New Zealand’s trade balance was negative for most of the June 2022 quarter, although it had a brief positive balance in April. The high cost of imported fuel and other goods continues to put pressure on the high returns of our products overseas. Unless exporting fuel, the high costs of production are being felt all over the world. 

7.0 The World

Australia

In the June 2022 quarter, inflation in Australia reached 6.1 percent, the highest increase in domestic prices since the early 1990s. The Reserve Bank of Australia (RBA) expects inflation to reach 7.8 percent by the end of the year, driven by disruptions to the global and domestic energy sector. Inflation is only expected to return to its target range of two to three percent by late 2024. 

Although the war in Ukraine has had little direct impact, higher global food and energy prices have resulted in favourable terms of trade for the country. Mining and energy export revenues are forecast to climb to a record $419 billion by 2023.

Like other high-income countries, the Australian economy is experiencing a combination of high inflation and record low unemployment. In the June quarter, unemployment was the lowest in five decades (3.5 percent). Not only is the supply of labour constrained, but demand for workers is also strong, with employers indicating their intention to employ more people. Both factors in combination suggest a further tightening of the labour market.

Looking beyond 2022, high inflation, tight monetary policy, and weakness in the housing market will weigh on GDP growth, which is expected to drop to under two percent in the 2023 and 2024 years. 

India

The war in Ukraine has had less of an impact on Indian energy prices as the country continues to import Russian oil and gas. While mounting global pressures have led to elevated inflation, July’s CPI reading of 6.7 percent was lower than in many advanced nations. The Reserve Bank of India believes that inflation has come off its peak. 

Both businesses and consumers remain optimistic. Fiscal support measures, such as a food scheme for poor households, tax cuts on fuel, and higher infrastructure spending will keep demand buoyant. Recent business-friendly reforms, such as lower corporate taxes, are expected to encourage higher private spending. GDP is forecast to grow by over seven percent over the coming year, supported by strong domestic demand that contributes over 70 percent to economic activity.

Overall, the Indian economy is relatively well-positioned to tackle current global headwinds. One of the key risks clouding the outlook is a deterioration of international demand for Indian exports as a global recession looms on the horizon.

China

China continues to adhere to its zero-tolerance policy for COVID-19. Nearly 60 million residents are currently in lockdown. Full eradication of the virus is now being prioritised over meeting Beijing’s 5.5 percent growth target for 2022. Industrial output grew by a slower than expected 3.8 percent in the year to July. The worsening property crisis is also dragging down the outlook for growth.

International forecasters continue to downgrade growth projections for 2022. As of July 2022, the IMF predicted a growth rate of just 3.3 percent for the 2023 year, which may be adjusted downwards again. 

Inflation, which remains low by global standards, reached 2.7 percent in the year to July 2022. This has given the People’s Bank of China more room to stimulate activity by lowering interest rates. The bank has already cut lending rates twice in 2022.

The effects of these prolonged lockdowns and a marked slowdown of domestic activity will continue to reverberate across the global economy, impacting global supply chains and the availability of key goods worldwide.

Japan

After over two years of mobility restrictions and COVID-19 resurgences, people are finally resuming spending at restaurants and malls, and on services like education, travel, and healthcare. In July 2022, household spending grew for a second consecutive month, driven by a rise in private consumption. 

Inflation is far more restrained than in other parts of the world. But, at 2.6 percent, it is still higher than Bank of Japan’s two percent target. Unemployment has also remained persistently low throughout the pandemic, and has been at 2.6 percent since May 2022. But, real wages are falling, which could hamper private consumption recovery.

The Bank of Japan is an outlier in its approach to tackling inflation, and continues to maintain its dovish approach by keeping interest rates steady at -0.1 percent. 

Looking ahead, strong fiscal support to soften the impact of rising oil prices will aid recovery. However, the world’s third largest economy is grappling with some of the same issues as rest of the developed world. Particularly, rising energy and food prices, the risk of a resurgence of COVID-19, and ongoing supply chain disruptions. All these factors will weigh heavily on industrial activity. 

Moreover, the yen is at its weakest in over two decades, adding more fuel to the inflationary fire. The IMF and World Bank both predict a GDP growth rate of just 1.7 percent for the 2022 and 2023 years.

USA

GDP fell for the second time in a row in the second quarter of 2022, shrinking by 0.9 percent on an annualised basis. The decline reflected lower private inventory investment, residential investment, and fiscal spending. 

This does not necessarily mean that a recession is inevitable. The labour market is still looking strong – the economy added over 520,000 new non-farm jobs during the month of July alone, and unemployment dropped to just 3.5 percent.

Although inflation cooled down slightly from the month prior in July 2022 to 8.5 percent, elevated prices will stick around for a while. Core inflation remained unchanged, increasing by 5.9 percent on an annual basis. The Fed has indicated that it intends to continue to increase interest rates “until the job is done”. Aggressive tightening by the Fed will result in lower demand, and eventually, lower economic activity. 

All in all, the current economic data paint a murky picture. While it is still unclear if the USA economy will go into a full-blown recession, activity is set to be subdued through to 2024 in response to tighter monetary and fiscal policies. As tighter monetary policy begins to take effect by mid-2023 and inflation starts to moderate, unemployment will also increase. 

UK

The war in Ukraine has hit the UK economy hard, derailing the path of post-pandemic recovery. Inflation is now into double digit territory, reaching 10.1 percent in July 2022. As a result of sanctions on Russian exports, wholesale gas prices nearly doubled between May and August. In response, the Bank of England (BoE) raised interest rates by 50 basis points, the biggest increase in 27 years. The BoE is growing increasingly pessimistic and expects CPI to reach 13 percent by the end of the year. It also foresees a recession by the fourth quarter as household incomes, and consumption, decline sharply.

Like in other developed nations, high inflation and low growth are accompanied by low unemployment, which stood at 3.6 percent in August. This is expected to increase as tighter monetary policy takes effect.

The future trajectory of GDP, over the medium-term, is largely dependent on how geopolitical tensions evolve and the path energy prices will take. As winter approaches, rising energy prices will further squeeze household budgets, and may push many into energy poverty. New Prime Minister, Liz Truss, has announced that household energy bills could be capped at £2,500 a year. This broad-based scheme will involve the transfer of taxpayer funds of around £150 billion to energy suppliers.

Europe

Europe managed to avoid a GDP contraction in the second quarter of the year, a fate that befell other countries such as the US, China, and the UK. This was mainly a result of a rebound in tourism. GDP increased by four percent during the year to June 2022. Unemployment also continued to fall, reaching 6.6 percent in June. 

However, the war in Ukraine is testing the resilience of the European economy. The war has exposed deep vulnerabilities in the region’s electricity market. Inflation in the area reached a new record high of 9.1 percent in August, and the European Central Bank raised interest rates by 75 basis points, the biggest increase in the Euro’s 24-year history.

Inflation is eroding real household incomes, and consumer confidence is falling. S&P Global’s Manufacturing Purchasing Managers' Index for the Euro Area was in the contractionary realm, at 49.6. A reading under 50 suggests declining activity. The IMF and the World Bank both predict a marked slowdown for the European economy in 2023. 

The European Commission is working towards a structural reform of the electricity market. Individual states within the area have rolled out their own measures to shield households from rapid price increases. For example, France has frozen gas prices at October 2021 levels, and is providing hand-outs to low- and middle-income households. Germany has reactivated coal plants that were due to be closed, and plans to expand wind farms. 

The region will have to overcome significant challenges in the next few months. There is a risk that Russia could cut off gas supply during the winter months. A complete stop of Russian gas imports to the region is expected to shave 1.8 percent off the region’s GDP. Interest rate hikes and shrinking real household incomes all weigh heavily on the region’s future prospects for recovery.

The path of global GDP growth

After seesawing between positive and negative during the pandemic era, GDP growth began to moderate towards the end of 2021 for most countries. The volatility to food and energy prices caused by the Russian invasion of Ukraine is currently the biggest threat to global GDP growth. An economic downturn in China, the second largest economy in the world, will also weigh heavily on global growth. The materialisation of downside risks associated with the war in Ukraine has meant that a significant economic slowdown is looking more and more likely.

On top of this, tighter monetary policy is viewed as a necessary evil by most central banks around the world to curb inflation. To help tide households and businesses over, most major governments have announced fiscal support measures to alleviate the burden of high food and energy prices. Such measures will undoubtedly cushion the blow of rapidly increasing prices for essentials.
 

8.0 BERL Forecasts

*BEFU forecast