Will recession be the new global headache after inflation comes down?

- The era of easy money has ended, with central banks engaged in a difficult balancing act as economies slow while structural inflation challenges persist, according to economist and strategist Timothy Ash

- Fed has been disaster since 2020, exploding money supply, causing inflation burst, and now excessively contracting supply, says applied economics professor Steve Hanke

ISTANBUL

Starting from the pandemic period, the world has been struggling with increasing or fluctuating prices, especially for food, housing and energy.

But after a tough period, consumer prices are nearing normal levels.

On the other hand, the tight monetary stance of central banks caused a downward trend in world markets and recession concerns emerged, especially in the US and some European markets.

Economists believe that central banks, particularly the US Federal Reserve, have gone "too far," and now there is no "easy money" for markets and recession possibilities are not negligible.

Steve Hanke, a professor of applied economics at Johns Hopkins University in the US, said inflation is not a global phenomenon. It's a local phenomenon depending on how much money is being circulated in each individual local economy.

"I examined the link between changes in the stock of broad money and inflation in 27 countries during the 2020-24 period," Hanke said.

"These countries account for over 75% of the world’s GDP. In the 27 countries I studied, the mean and median lags witnessed in the 2020-24 inflation rollercoaster were 23.9 and 23 months, respectively."

He said there is a very clear pattern in all cases. First, the rate of growth in the money supply changed, and then, with a lag, inflation changed its course.

Since the COVID-19 pandemic o­­f 2020, most countries have witnessed a rapid runup in inflation followed by a hasty retreat, and for some nations, the trip’s been a "wild rollercoaster ride," a lurching ascent towards a summit where the houses below look like Monopoly pieces followed by a steep, head-spinning drop, he said.

For others, the journey has resembled a snowmobile’s wintry climb up a low, sloping hill and the gliding descent down the other side, Hanke stressed.

"The amplitude of the inflationary ramp varied from wild to mild. The wild upward swings happened in the US, UK, eurozone, Denmark, Sweden, Canada, Australia, New Zealand, Argentina, Brazil, Egypt, Ghana, Israel, Mexico, Nigeria, Peru, the Philippines, Sri Lanka, Thailand and Türkiye," he said, adding the up-and-down ride was mild in China, Japan, Switzerland, Malaysia, India, Indonesia and South Africa.

Economist and strategist Timothy Ash said it has been a painful path to drive inflation lower, but with global growth struggling, this will likely help in the disinflation trend.

"We do though still face structural headwinds on inflation — rising protectionism, carbon transition and a focus on ESG (environmental, social, and governance) which increases costs to business, plus also anti-immigration policies. So, (there are) still risks on the inflation front," he added.

Ken Wattret, a global economist at US-based S&P Global Market Intelligence, said inflation rates are generally well below their peaks in 2021-2022 and further gradual declines are forecast as supply and demand continue to rebalance.

The timing and magnitude of the declines in inflation over the past couple of years have varied across countries, reflecting differences in various inflation drivers, including demand conditions, labor market tightness, sensitivity to shocks, and item weights, he stressed.

Global consumer price inflation has dropped from a peak of 8.3% in September 2022 to 4.5% in April 2024, according to S&P Global Market Intelligence estimates.

The gradient of the declines has flattened since mid-2023, however, reflecting the relative stickiness of some prices, particularly for services, noted Wattret.

"Disinflation in core goods, which is relatively sensitive to global factors such as commodity price swings and supply-side bottlenecks, has been very pronounced," he underlined.

The aggregate core goods inflation rate in five key economies (the US, Canada, the eurozone, the UK and Japan) turned negative in March and April 2024 for the first time since early 2020 during the early stages of the pandemic. At minus 0.4% in April, the inflation rate has fallen by around nine percentage points from its peak in early 2022, he said.

Wattret added that the equivalent inflation rate for services prices, which are generally more sensitive to labor costs, fell to 4.8% in April, around one-and-a-half percentage points below early 2023's peak.

With wage growth rates expected to continue to moderate, services inflation rates are forecast to gradually trend downwards, he stressed.

"Longer-term prospects for underlying inflation rates will be determined by a range of influences, including the evolution of spare capacity, inflation expectations, labor cost trends and profit margins. These will vary at the country level, but most are expected to remain consistent with moderating inflation," he added.

Boris Balabanov from the International Monetary Fund (IMF), citing the fund's economic outlook report from the last month, said on inflation developments, the global disinflation momentum is slowing, signaling bumps along the path.

This reflects different sectoral dynamics: the persistence of higher-than-average inflation in services prices, tempered to some extent by stronger disinflation in the prices of goods, he said.

He noted that the uptick in sequential inflation in the US during the first quarter has delayed policy normalization, and this has put other advanced economies, such as the euro area and Canada, where underlying inflation is cooling more in line with expectations, ahead of the US in the easing cycle.

Central bank moves

Related to major central banks' moves against price developments, Hanke said: "For example, in the US, the money supply is now lower than it was in July 2022. That’s why inflation has decreased, and I anticipate it will end the year between 2.5% and 3%. This is also why I think the US economy will likely enter a recession in late 2024 or early 2025."

In short, the Fed has been a disaster since 2020; first, it exploded the money supply and caused a burst in inflation, and now it is excessively contracting the supply, Hanke underlined.

Wattret said that getting the balance right between lingering inflation concerns and recession risks remains a major challenge for the world’s central banks.

"Recent market corrections have led to a huge shift in US rate cut expectations, and our initial take is that it’s gone too far. While some Fed officials have tried to soothe market worries recently, they’ve continued to signal that they will be considering rate cuts in the coming months, not imminently, and that recessionary fears are overdone."

"We've seen huge swings in US rate cut expectations before — at the end of 2023, for example, futures markets priced in more than six Fed rate cuts this year, starting in March.

"That was way overdone, too. It doesn't mean that a US recession is impossible — we can't rule one out — but the evidence to support it looks unconvincing at this point," he added.

He noted that as things stand, even after some recent stabilization, futures markets currently discount a 70% chance of a 50-basis-point Fed cut at the next meeting in September and well over 100 basis points of cuts over the remainder of the year — in other words, a high chance of at least two 50-basis-point rate cuts or even inter-meeting moves, which are quite rare.

"It's important to stress that some of the recent developments do signify a material change — the BoJ (Bank of Japan) hasn't been hiking rates for decades, and the unwind of carry trades has the potential to cause considerable market volatility," he said.

"In a scenario of an equity market meltdown, the related tightening of financial conditions would likely result in the Fed cutting rates faster, earlier — but that's not our base case."

Ash also said the Fed and other central banks were engaged in a difficult balancing act, with economies slowing while structural inflation challenges persist. According to him, the "era of easy money has gone."

Balabanov stressed the implications for monetary policy, saying that in countries where upside risks to inflation — including those arising through external channels — have materialized, central banks should refrain from easing too early and remain open to further tightening should it become necessary.

Where inflation data encouragingly signals a durable return to price stability, monetary policy easing should proceed gradually, he added.

Türkiye

On Türkiye, where the current official annual inflation rate is 61.8%, Hanke said: "My inflation measure is now much lower, at 26% per year.

"I make my measurements daily, using high-frequency data. As a result, my inflation measures tend to lead the official measures," he pointed out.

This suggests that the official inflation rates will continue to come down.

"But, there is still a long way to go before Türkiye will hit its inflation target of 5% per year," he underlined.

Ash said the road ahead for Türkiye remains challenging as high inflation in entrenched. He said it was positive that the Central Bank has returned to economic orthodoxy.

Further, he added that the country's currency, the lira, has stabilized with favorable base effects. "We should see a rapid decline in headline inflation from the 70s to the 30s by year-end."

So far, there has not been much growth given up, as the re-establishment of stability has helped improve confidence and that has underpinned growth, but it becomes more difficult, and it will need a sacrifice in terms of growth, and that will be politically more difficult, he said.

But in the end, the population cares more about lower inflation than growth, he added.