08-09-2023 11:32

Nordea Chief Economist: It's too early to declare victory over inflation

So far, the global economy has been very resilient to the significant monetary policy tightening. Inflation is still high, however, and there is a good chance monetary policy will need to be tightened further before central banks can declare victory over inflation. Growth prospects remain moderate and subject to high uncertainty. This is in part due to heightened geopolitical uncertainty, which leads to new patterns in international economic relations.
Group Chief economist Helge J. Pedersen

So far, the global economy has been very resilient to the significant monetary policy tightening. Labour markets are still strong in most countries, and inflationary pressures have eased considerably following the sharp drop in commodity and energy prices. At the same time, the COVID-19 pandemic no longer poses a risk of  society being locked down and disrupting supply chains again.

The labour-intensive service sector has especially benefitted from the positive trend after the reopening of the economies and the pent-up demand for leisure activities. Conversely, the manufacturing sector is severely affected by destocking and higher financing costs. This trend could also spread to some extent to the service sector.

A soft landing for the global economy currently seems to be the most likely scenario, and on that basis, we find no reasons to radically change our forecast for the global economy. We thus expect growth to be just below 3% this year and slightly lower in both 2024 and 2025 - the latter is included in our forecast for the first time.  

However, it should be noted that our forecast is subject to great uncertainty. Firstly, significant monetary policy tightening has, somewhat surprisingly, not had the desired effect on the economy yet. This may be because the assessment of the neutral interest rate has been too low, and that the first of many rate hikes did not make  monetary policy contractionary, but only less expansive. If so, the interest rate must be kept higher for a longer period than previously expected, or hiked further to have the desired effect on the labour market and wage trends in order to fight inflation.

Nevertheless, we still expect central banks to end the hiking cycle this year, as the effect on economic activity is reinforced by commercial banks’ stricter loan conditions for households and businesses in these uncertain times. Note that this effect is especially pronounced in Europe, where banks provide a far greater share of companies’ financing than in the US. Also, monetary policy changes feed through here at a greater lag than previously, as the number of home loans with fixed interest and long maturity has in-creased since the financial crisis.

Secondly, the geopolitical situation is still very uncertain, not least due to the war in Ukraine, relations between the US and China and, most recently, the tensions related to the Niger coup.

The new reality may also lead to deeper geoeconomic fragmentation. This basically means that countries will increasingly focus on economic and political relations with other countries that belong to the same alliance or bloc. This implies a clearly growing risk of increased use of sanctions and other restrictions on free trade and investment activities across borders.

The economic consequences will probably be permanently higher inflation, lower growth and larger fluctuations in commodity and energy prices than before the pandemic and the war in Ukraine. 

It’s too early to declare victory over inflation without serious economic side effects.

Helge J. Pedersen, Nordea Group Chief Economist

The tendency of structurally higher inflation may even be reinforced by the ambitious green and digital transition, which will also lead to new incentive taxes and duties as well as much higher demand for a number of industrial metals and rare earth minerals. 

The prospect of lower potential growth in the global economy, and not least in western countries, is also supported by demographic challenges and the growing importance of the labour-intensive, but also low-productive, service sector in the global economy.

However, in the slightly longer term, artificial intelligence (AI) may prove to be the solution to growth challenges. Much indicates that the use of AI could over time replace a great deal of everyday work routines and thus significantly boost productivity. This opens up enormous opportunities, but will also require massive investments in new technology as well as in retraining the labour force for new jobs. Jobs that may not even exist today. This is a trend that has always followed in the wake of large technological leaps.

Like many others, the Nordic countries are at different stages of the economic cycle. The Danish economy is in great shape, although the extraordinary performance of the pharmaceutical sector blurs the actual picture. The Norwegian economy has also proven to be very resilient to massive rate hikes, while Finland and not least Sweden have been more affected by significant monetary policy tightening and the global downturn in the manufacturing sector. 

So, even though the Nordic countries show great resilience, it is also too early in this part of the world to declare victory over inflation without severe economic side effects.

This article originally appeared in the Nordea Economic Outlook: Not there yet, published on 6 September 2023. Get the latest Nordea Economic Outlook


Helge J. Pedersen
Nordea Group Chief Economist
Economic Outlook