What Might 2023 Hold?

The re-opening of economies after Covid meant strong demand met limited supply, causing inflation to rise sharply. Higher interest rates are the most conspicuous result – and they are likely to persist in 2023 before dropping the following year – but they are just one facet of the key macro trends we expect to define the coming years as we move into a new economic regime.

In partnership with the Economic and Investment teams at Schroder Investment Solutions (SIS), as well as using data from Visual Capitalist, we take a look at key themes that we predict will drive the direction of the global economy this year and what they mean for investors.

You can also click here for an infographic overview of what the year might hold.

INFLATION

As the top economic story of 2022, inflation would seem the logical place to start. Following the re-opening of economies post-Covid, strong consumer demand met limited supply, driving inflation up sharply and sparking a phenomenon not experienced for decades by investors.

Central banks were slow to react, blaming unpredictable factors such as the war in Ukraine for the temporary spikes in energy and agriculture prices. With inflation at its highest level in some 40 years, they have been left with little choice but to play catch up and prioritise controlling inflation over focusing on growth, even if that means causing a recession.

In short, the scale of inflation means that interest rates have to rise further in the short term and stay higher for longer, which will put economic growth on the back burner for the foreseeable future.

How central banks have responded to inflation:

FISCAL INTERVENTION

Experts predict that governments will continue to adjust their taxation and spending policies, as they try to support businesses and households throughout the economic downturn. With large post-Covid deficits sitting on government balance sheets, rising interest rates are piling on the pressure for governments to apply austerity. However, there are many countries which oppose this approach, instead preferring a policy of increased spending. Either way, any fiscal stimulus risks stoking inflation, opposing the actions of central banks, which may also come under further fire as politicians’ feelings towards higher interest rates become more prominent.

EAST VERSUS WEST

As the world’s second largest economy, events in China have a major impact on the global economy. Severe Chinese lockdowns during the pandemic caused widespread supply chain blockages (particularly in technology), adding to inflation and increasing the strain on the already fragile political relationship between China and the West. The impact of the war in Ukraine also widened geopolitical fault lines, as it triggered a reshape of the global energy landscape and threatened a greater divergence between the two parties.

In response, companies are seeking ways to diversify their production processes, with many choosing to relocate closer to home. This means one of the greatest deflationary forces of recent decades, the growth of low-cost production in China, is weakening and may have run its course.

Increased talk of bringing production back home:

Over in the US, friction continues with China over the video app, TikTok, with experts predicting that regulators will either ban the app altogether or force the sale to an American entity. The row began a few years ago, when Donald Trump accused the video-sharing social networking service of being a threat to national security, claiming its Chinese parent company, ByteDance, would give the Chinese government access to user data upon request, an accusation TikTok denies.

TECHNOLOGY

Jobs being displaced by automation is far from a new theme. However, experts predict that artificial intelligence (AI) will impact people’s lives in a much more tangible way in 2023, as AI start-ups force big tech companies to innovate faster, and employees discover new ways to use AI-powered tools to ramp up productivity as means of offsetting rising production costs caused by higher commodity prices and higher staffing costs.

Labour shortages are also taking their toll on profit margins, with curbs in migration tilting the power of wage negotiations back towards the workforce, as are rises in taxation, both of which are driving up the cost and prices of production in the near term. In response, experts believe businesses have one clear route to increase productivity – technology – using robots and AI where feasible.

ENERGY & CLIMATE CHANGE

The global system that supplies us with energy is extremely complex due to the volume of unpredictable factors that can affect its stability, most notably the impact of global conflict. Following the invasion of Ukraine, the UK is seeking to diversify its energy imports away from Russia, whilst brewing conflicts in Iran could also have a knock-on effect on the energy industry this year.

As businesses worldwide continue to widen their energy sources and transition to renewable energy, inflation is being driven structurally higher in a number of ways.

1. 1. By the cost to create the required capacity
2. 2. By the higher initial cost of switching to a more expensive source of energy and;
3. 3. By the costs imposed through regulation to force the switch

On a more positive note, the threat from climate change will prompt greater investment in technological solutions which, if successful, could help lower the inflationary impact and improve the outcome for economies worldwide.

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Source: Visual Capitalist and Schroders.