The global economy fears a new downturn

After a record tourist season, analysts paint a bleak picture due to Putin’s war and rate hikes. The US is already a cause for concern and the EU may be even worse off

A gas station in Madrid.
A gas station in Madrid.Samuel Sánchez
Lluís Pellicer

For two months it’s been impossible to get a table at any of Romain Fontell’s four restaurants. The bustle has returned to Barcelona. After two stagnant years, cruise ships, big concerts and festivals have finally returned to the city, along with the throngs of tourists. Hotels are hanging no vacancy signs again and money pouring in at restaurants is filling cash registers. It’s the kickoff to a promising summer. “The numbers have already overtaken 2019 and the forecasts for the coming months are very good,” celebrates Fontell. His restaurants have survived the pandemic and he says they’ve learned to deal with inflation. But he doesn’t want to anticipate what might happen in the fall. “We’ve learned to live day by day,” he says. But by then, new threats will cloud the economic recovery again. Indeed, analysts are already seeing signs of recession.

Economic forecasting has become impossible, even in the short term. The post-pandemic recovery has been losing steam. A year ago, international organizations predicted a very strong growth in the eurozone, close to 4%. The European Central Bank (ECB) was the last institution to lower it, to 2.8%. At other times, any economist would think twice before uttering the word “recession.” That’s no longer the case. Headwinds are blowing towards Europe from all directions, especially from Russia. The prolongation of war in Ukraine and the adoption of new rounds of sanctions may sharpen the rise in prices and further damage growth in the eurozone. If Moscow decides to turn off the gas tap, Europe may even find itself facing a freezing winter.

Everything suggests that Europeans have decided to take a break during the summer. In Spain, where people still have accumulated savings and where there’s been an improvement in the labor market with more permanent contracts, this means that hotels and restaurants will be bustling. “We are seeing that consumers are willing to spend their savings, and leisure and tourism are included in this plan. Everything suggests it’s going to be a good season,” says Ángel Talavera, an analyst at Oxford Economics. From the command posts of the EU, summer in Spain, Italy and Greece is expected to offset the setback that industry and construction in Germany might experience this quarter.

But among economists, expressions such as “black autumn” are beginning to spread. “Let’s keep our fingers crossed,” is all that the Barcelona restaurateur, Fontell, can say. If nothing goes wrong, Europe will continue to grow. The influential German institute Ifo expects the European locomotive to grow by 2.5% this year and 3.7% the following. Its director of Analysis, Timo Wollmershäuer, explains that the war in Ukraine, the energy crisis and the confinements in China have already forced forecasts for this year to be cut by 1.5 points compared to those made at the end of 2021. “If all of this had hit the German economy in normal times, we would have fallen into recession,” he says.

The forecasts of all the organizations, however, are full of asterisks and footnotes. Risks connected with the pandemic are dissipating, but new geopolitical threats are emerging. “In Europe, the story could be even bleaker than in the United States because of the prospect of a Russian energy boycott,” warns Adam Tooze, a historian and professor at Columbia University.

The ECB has outlined an alternative scenario to its central forecasts in which it contemplates a total closure of the natural gas tap by Vladimir Putin. The Kremlin has already blocked the flow to several EU partners, such as the Netherlands and Finland, and has reduced supply to Germany, France, and Italy. Europe fears, however, that Moscow will go further, with cuts that imply rationing and with prices that continue to skyrocket.

This hypothesis, according to the ECB, already suggests a much weaker growth for 2022, of 1.3%, and a contraction of 1.7% in 2023. Inflation would also become more persistent and would stand at an average of 8% this year and 6.4% the following. Higher prices would eat into household income and consumption would be depressed. In other words, the much-feared stagflation.

The pandemic has shown how quickly any crisis, whether due to health or economic reasons, can spread across the planet. And Europe’s main trading partners are beginning to show signs of exhaustion. This week, in the United States, an overheating economy has already seen two phenomena that have not gone unnoticed by economists. First: Wall Street entered an unmistakably bearish path after accumulating losses of more than 20% since its historical peak on January 4. Second: the interest curve was inverted; that is, the two-year bonds yielded more than the ten-year debt, indicating short-term pessimism. In both cases, analysts see signs that a recession is on its way.

More alarming than these two signs is the consensus of economists and entrepreneurs who already speak openly of a recession in 2023, though they maintain it’ll be short-lived; 70% of economists surveyed by the Financial Times hold this view. “Inflation is above target and the Federal Reserve must reduce it by raising interest rates and slowing down demand and the economy,” says Jonathan Wright, professor of economics at Johns Hopkins University, who coordinated the survey.

The central bank, chaired by Jerome Powell, wants its aggressive interest rate policy to cause, at most, a soft landing for an economy that quickly recovered from the pandemic and with a very strong labor market. However, Wright considers this unlikely. “Given the inflation situation, it’s clear that the Fed needs to tighten financial conditions quickly – and it will – even if the cost is to cause a recession,” he says.

Adam Tooze, who highlights this “dramatic change” in expectations, says he is primarily concerned about the US housing market. “Mortgage rates have increased from 3% to 6% in just six months. By 2023, a price drop is predicted. The US real estate sector is the largest single form of wealth in the world economy,” he adds. On top of this this is the collapse of the cryptocurrency market, which had already become popular as an investment.

There is also no good news from China, the EU’s other major trading partner and at the same time its “systemic rival,” in the words of Brussels. Beijing’s zero-Covid policy, based on lockdowns to fight new outbreaks, continues to prevent the end of bottlenecks and adds to the great global traffic jam, intensifying surging inflation. The investment bank Nomura expects growth for the Asian giant of 3.3%, a modest figure in relation to the frenetic pace of expansion of the Chinese economy in recent years. And that figure may decrease, according to the company, if the property bubble that began with the Evergrande real estate crisis ends up bursting.

However, these aren’t all the dangers. The world is also awaiting the resolution that the ECB gives to the dilemma between growth and inflation. Southern countries accept that rates should be raised, but with great care so that the recovery is not derailed. Those in the north think that Frankfurt is too late. “The ECB has yet to admit that it will have to raise interest rates well into positive territory, above 3% and possibly much higher. This will slow down the economy. The war in Ukraine increases the chances of recession. It is frustrating to see that the ECB is still dragging its feet,” says Charles Wyplosz, a professor at the Graduate Institute in Geneva.

However, the south of the euro zone, led by Italy, held its breath after witnessing a rise in risk premiums just from announcing the first rise in interest rates. The biggest fear: a throwback to the debt crisis of 2010, which was also the euro crisis. Athanasios Orphanides, now a professor at the Massachusetts Institute of Technology business school, was then governor of the Central Bank of Cyprus and a member of the governing council of the ECB. He believes that the problems that hit the euro zone back then have not yet been resolved. “As the ECB tightens policy, we may see a more significant tightening of monetary conditions in Italy and Spain, for example. That could lead to catastrophic results in those member states, but the whole euro area is going to suffer,” he says.

If all those risks materialize, the big question is how intense the backlash will be. Lorenzo Codogno, a former Italian treasury secretary and professor at the London School of Economics, believes that the recession should be short-lived and limited to just a few countries. Also, let’s not forget that this time Europe has an instrument whose deployment has only just begun to support investment: a recovery fund of up to €800 billion.

Edited by Xanthe Holloway

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