S&P: Macro mood improves after Davos, but inflation & rate hike risks remain

The macro mood post-Davos has improved noticeably. This mainly reflects relief over the resilience of the European economy including gas availability, and optimism over China’s surprising early (and abrupt) exit from its zero-COVID policy, Report informs referring to S&P Global Ratings.

While both developments are positive for the global economy, S&P Global Ratings believes they add fuel to the dominant macro risks: inflation and rate rises.

“On the eurozone, we were not surprised by the resilience. Our out-of-consensus call had included a boost from the production side, as supply chain bottlenecks eased and firms began to clear order books. This despite the hit on growth from higher rates and tighter financial conditions. We could not have predicted Europe's mild winter, but this has also been helpful to economies.

On China, the timing and pace of the opening did surprise us. Our forecast assumed this would happen in a more gradual fashion (i.e., with Chinese characteristics) over the first part of the year. The earlier reopening keeps China on track for close to 5% growth this year despite a weak finish to 2022. But the demand spillover will be limited given that the recovery will be skewed toward consumer spending and, therefore, largely domestic,” reads the report.

China’s reopening will add to global inflation pressures. Commodity prices are rising already. This will complicate macro policy in countries where the focus is already squarely on bringing down inflation.

“As such, we are taking the Davos euphoria in stride. We explain why, and reaffirm our current macro view through the lens of the "big three" economies. Given what is currently moving the global macro needle, which have rearranged the usual ordering of our discussion to: first the eurozone, then China, and finally the US and emerging markets,” the agency noted.

S&P believes that the recession risks may have declined, but the main macro challenge remains inflation. “Specifically, how will policy rate increases--and tighter financial conditions--needed to bring inflation back to target play out in 2023 and beyond? Stronger momentum is a two-edged sword. It provides tailwinds to growth but raises the possibility that rates may need to go higher to rein in demand, and bring inflation back to target.

The bottom line is that we are affirming our baseline scenario. However, upward growth revisions risk higher rates for longer, and the associated negative effects on output over the medium term.”