Interest rates, inflation will mar global economic recovery: OECD

Click to play video: 'IMF says U.S. inflation remains ‘stubbornly high,’ forecasts peak of 5.4% in 2023'
IMF says U.S. inflation remains ‘stubbornly high,’ forecasts peak of 5.4% in 2023
International Monetary Fund (IMF) chief Kristalina Georgieva said on Friday that U.S. interest rates will likely need to remain higher for longer to tame inflation, forecasting that the federal funds rate will peak at 5.4 per cent in 2023 and ease to 4.9 per cent in 2024. “Inflation remains stubbornly high,” Georgieva said. “It’s telling us the job is not quite yet done.” – May 26, 2023

The global economy must steer through a precarious recovery this year and next as inflation keeps dragging on household spending and higher interest rates weigh on growth, banks and markets.

That was the takeaway Wednesday from the latest economic outlook by the Paris-based Organization for Economic Cooperation and Development. The group, made up of 38 member countries, raised its growth forecast this year to 2.7 per cent from an estimated 2.2 per cent in November and foresaw only a tiny acceleration to 2.9 per cent next year.

The rebound from the COVID-19 pandemic and energy price spike tied to Russia’s invasion of Ukraine is likely to be weak by past standards, with average growth of 3.4 per cent recorded in the pre-pandemic years 2013-2019.

The path ahead is fraught with risks, from escalation of Russia’s war in Ukraine — with a dam collapse Tuesday that the sides blamed on each other — to debt troubles in developing countries and rapid interest rate hikes having unforeseen effects on banks and investors.

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“The global economy has begun to improve,” OECD Secretary-General Mathias Cormann said at a news conference. “We are projecting a recovery over 2023 and 2024. However, at this point, it is a recovery to low global growth.”

“Economic indicators are showing some improvement,” he said. “But the upturn remains fragile.”

Click to play video: 'Tips to combat inflation: investment advisor'
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It was a more optimistic outlook than the World Bank gave Tuesday, citing similar risks in its expectation for 2.1 per cent global growth this year. That was still an upgrade from its January forecast of 1.7 per cent.

Energy prices have fallen to pre-invasion levels, helping ease the worst of the recent outbreak of inflation. But those costs are still higher than they were before Russia began massing troops on Ukraine’s border in early 2021.

Meanwhile, China’s reopening after drastic pandemic measures has provided a boost to global activity.

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Click to play video: 'Why mortgage and rent costs drove inflation up in Canada'
Why mortgage and rent costs drove inflation up in Canada

But core inflation, which excludes volatile energy and food prices, is proving persistent as some companies raise prices to increase profits and workers push for higher wages amid relatively low unemployment.

The OECD sees inflation declining to 5.2 per cent by year end from 7.8 per cent at the end of last year in the Group of 20 countries that make up more than 80 per cent of the global economy. The U.S. should see annual inflation of 3.2 per cent by the last quarter of this year, and Europe’s rate should fall to 3.5 per cent.

Those levels would provide some relief but are still above the 2 per cent inflation targets for the European Central Bank and U.S. Federal Reserve, which have been rapidly raising interest rates to fight inflation. That increases the cost of borrowing to buy houses and invest in business expansion.

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Click to play video: 'Inflation still wreaking havoc after BOC’s decision to hold steady on interest rates'
Inflation still wreaking havoc after BOC’s decision to hold steady on interest rates

The OECD cautioned that while central banks need to maintain policies that restrict credit, they “must keep a watchful eye, given the uncertainties around the exact impact” of the rapid hikes.

“Signs of stress have started to appear” as higher borrowing costs slow property markets and raise concern about the impact of more expensive credit, the organization said.

Countries that spent on pandemic relief for households and businesses already are grappling with higher public debt and now have the added burden of more expensive costs to pay it down.

The United States and Europe both can expect only tepid growth.

Click to play video: 'U.S. Federal Reserve raises interest rates by 0.25%, acknowledges ‘inflation pressures’'
U.S. Federal Reserve raises interest rates by 0.25%, acknowledges ‘inflation pressures’

The U.S. is facing challenges from higher borrowing costs in rate-sensitive areas like housing construction and manufacturing. As demand slows, unemployment is expected to gradually rise toward 4.5 per cent in 2024 — up from 3.7 per cent in May. With more jobs available and fewer pay increases, inflation is expected to moderate.

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“Nonetheless, the economic outlook could worsen if rising interest rates expose further financial fragilities,” the OECD said.

The failure of Silicon Valley Bank and two other U.S. lenders highlighted problems that could emerge in the banking system if financial institutions suffer losses on investments like bonds, whose value falls when rates go up.

Most of the globe’s growth will come from Asian economies such as China, India, Indonesia and Singapore. Growth in China is expected to reach 5.4 per cent this year and 5.1 per cent next year as services such as tourism and entertainment recover from COVID-19 lockdowns and infrastructure spending supports a construction boom. Exports should be tempered by weak global demand.

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