The International Monetary Fund says the risk of a “hard landing” for the global economy has risen sharply as a result of stubborn inflation and recent strain in the U.S. and European banking sectors.
The IMF’s biannual World Economic Outlook, published Tuesday, left the fund’s global growth forecast largely unchanged. However, it warned that risks to the outlook are now “heavily skewed” to the downside.
“On the surface, the global economy appears poised for a gradual recovery from the powerful blows of the pandemic and of Russia’s unprovoked war on Ukraine,” Pierre-Olivier Gourinchas, the IMF’s economic counsellor and head of research, wrote in the introduction to the report.
“Below the surface, however, turbulence is building, and the situation is quite fragile, as the recent bout of banking instability reminded us.”
The publication launches the spring meetings of the IMF and the World Bank in Washington. Finance ministers and central bankers, including Chrystia Freeland and Bank of Canada Governor Tiff Macklem, are also attending a meeting of the G20 in Washington this week.
The report is shot through with a sense of uncertainty. Many large economies, including the United States, China and the euro zone, have performed better than expected through late 2022 and early 2023 – belying the IMF’s gloomiest recession forecasts from last year.
At the same time, inflation is proving more stubborn than expected in many countries. And the recent turmoil at Silicon Valley Bank and Credit Suisse has highlighted the risk of a financial crisis, making things harder for central bankers who now have to balance inflation fighting against financial stability concerns.
“The sharp policy tightening of the past 12 months is starting to have serious side effects for the financial sector,” Mr. Gourinchas wrote, referring to the rapid pace of interest rate hikes by many central banks around the world.
Prompt action by central bankers and regulators appears to have contained the dysfunction that emerged in the British bond market last fall and stopped the spread of financial contagion during the recent tumult at U.S. and Swiss banks, Mr. Gourinchas wrote. But the global financial system could be tested again, he said.
“We are therefore entering a perilous phase during which economic growth remains low by historical standards and financial risks have risen, yet inflation has not yet decisively turned the corner.”
The IMF’s baseline scenario is for the world economy to grow 2.8 per cent this year, down from 3.4 per cent in 2022. It’s projected to then grow 3 per cent in 2024. That’s a small upgrade to the fund’s October World Economic Outlook, but a slight downgrade from a more hopeful estimate published in January. Advanced economies, including Canada, are expected to grow at a slower pace.
The report presents a “plausible alternative scenario,” where the stress in the banking sector leads to a more significant pullback in lending, as banks look to cut their exposure to risk. In this situation, global GDP would grow by only 2.5 per cent this year.
The IMF also sees a roughly 25-per-cent chance that global growth could fall below 2 per cent, a level often taken to imply a global recession. That is double the normal probability.
Canada is expected to perform relatively well compared with peers over the next two years. The IMF sees the Canadian economy growing 1.5 per cent in both 2023 and 2024, which would make it the second-fastest-growing G7 economy this year and the fastest growing next year. In addition, inflation in Canada is expected to fall faster than in many peer countries.
The Bank of Canada will publish its own updated inflation and economic growth forecast on Wednesday alongside its interest rate announcement.
Looking further out, the IMF expects medium-term global growth to be the weakest in decades, settling at around 3 per cent in five years.
“Some of this decline reflects the growth slowdown of previously rapidly growing economies such as China and Korea. This is predictable: Growth slows down as countries converge,” Mr. Gourinchas wrote.
“But some of the more recent slowdown may also reflect more ominous forces: the scarring impact of the pandemic; a slower pace of structural reforms, as well as the rising threat of geoeconomic fragmentation leading to more trade tensions.”
A separate IMF report on financial stability, also published Tuesday, said the risk of a major financial crisis is lower today than it was in 2008. Banks have better capital and liquidity buffers, and central banks have more experience responding to financial shocks.
Still, tight monetary policy could trigger bouts of financial instability, according to Tobias Adrian, the IMF’s financial counsellor.
“Activities in riskier segments of capital markets such as leveraged loans and private credit markets have slowed. Concerns have also been growing about conditions in commercial real estate markets, which are heavily dependent on smaller banks,” Mr. Adrian wrote in an introduction to the report.
“While banking stocks in advanced economies have undergone significant repricing, broad equity indices remain very stretched in many countries, having appreciated markedly since the beginning of the year. A more extensive loss of investor confidence or a spreading of the banking sector strains into nonbanks could result in a broader sell-off in global equities.”