Spend or Save?

Inflation’s continued squeeze on household income will be the major story in the second half of the year. A new exogenous inflationary shock due to the surge in commodity prices resulting from the Russian invasion of Ukraine has wreaked havoc on the global economy at a time when it was still recovering from the Covid-related recession. Consumer attitudes to savings will play a crucial role in the timing and depth of the probable slowdown ahead.

Having accumulated excess savings of around 10% of GDP in most advanced economies during the pandemic, consumers could go one of two ways. They could eat into those buffers, leading to a gradual slowdown and, most likely, forceful monetary tightening. Alternatively, households could cling to their savings for precaution against the backdrop of the sharpest cost-of-living increase in decades and elevated uncertainty. The latter scenario would pose an acute growth-inflation trade-off and a policy dilemma for central banks.

In either case, the chance of a recession in developed economies is above even for next year. The most recent global composite PMI readings are consistent with global output growth of about 3%, which would be below rates of around 3.5% prevailing before the pandemic and well below forecasts for global growth made earlier this year of 4-4.5%. Although inflation is probably close to its peak, it is likely to remain elevated for the balance of the year, contributing to an uncomfortable growth-inflation trade-off for policymakers. On balance, central banks likely will tighten over the next few quarters, as their credibility—the most powerful tool they harness—is on the line. While the direction of travel will be the same across the board, the speed and the destination will vary across regions. The Federal Reserve is leading the global tightening cycle, while European central banks are proceeding more cautiously.

One positive is that the Chinese economy has probably bottomed from the lockdowns that probably caused its economy to contract in the second quarter. The gradual reopening of Shanghai and targeted fiscal/monetary stimulus should reboot growth.