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      Sovereign mid-year outlook: slowdown, inflation, rising rates create divergent ratings trajectories
      MONDAY, 18/07/2022 - Scope Ratings GmbH
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      Sovereign mid-year outlook: slowdown, inflation, rising rates create divergent ratings trajectories

      The global economy is slowing. We forecast growth will slow to around 3.1% this year, compared with 4.5% under our December 2021 projections. Global growth of 3.6% is expected for 2023, although the skew of risk for our outlook remains to the downside.

      Download Scope’s 2022 Sovereign Mid-Year Outlook.

      Scope’s global economic outlook, summary, as of 18 July 2022

      “We are forecasting weaker global growth for 2022 but our forecast remains consistent with an economic baseline entering this year, of above-potential for the calendar year but uneven economic growth. While there is significant likelihood of technical recession over 2022-23 in certain countries, such recessions are likely to be mostly shallow with annual growth rates probably remaining moderately positive,” said Giacomo Barisone, Scope’s head of sovereign and public sector ratings. “Annual growth for 2023 will display further slowdown or normalisation across many economies, although China is a crucial exception here, as high prices restrict purchasing power while post-Covid rebounds fade in force.”

      One legacy of the Covid-19 crisis has been a government debt overhang. In this respect, high inflation can be credit positive near term for sovereign ratings via the trimming of debt ratios. However, inflation derails real economic growth and, with time, increasingly constrains central banks’ room for manoeuvre should price-stability mandates be compromised. “As such, if persistent inflation restricts lender-of-last-resort functions of a central bank to intervene during market failures, current conditions lean towards being credit negative,” said Dennis Shen, lead author of the Sovereign Outlook.

      Stagflationary conditions hold divergent positive and negative effects for sovereign ratings, with more sovereign borrowers seeing downside rating actions than upside actions since escalation of the Russia-Ukraine war. Since 24 February 2022, we have revised three countries’ ratings lower: Russia (WD), Ukraine (CCC/Negative), and Turkey (B-/Negative). We have changed three rating Outlooks to Negative: Japan (A), China (A+), and Czech Republic (AA) and revised higher only three countries’ ratings/Outlooks: Croatia (BBB+/Stable), Portugal (BBB+/Positive), and Cyprus (BBB-/Positive). Russia has defaulted while Ukraine contemplates debt restructuring.

      Impediments to global growth include elevated energy and commodity prices, weakened economic sentiment and a slowdown of economic trading partners. Inflation remains elevated even with tighter monetary policy. “Even when inflation peaks and starts to moderate over coming quarters, significant market instability and correction are likely, although we do not anticipate a global financial crisis,” said Shen.

      Barisone added: “economic slowdown and the gradual easing of elevated inflation will cause front-loaded central bank tightening to decelerate, halt or even reverse in cases by 2023. Currency depreciation is seen forcing tightening by more dovish central banks such as the ECB or they risk importing further inflation.”

      We have cut GDP growth forecasts for this year, to 2.8% for the euro area, 3.5% for the UK, 1.7% for the US, 3.6% for China, and 1.8% for Japan. Next year, continued moderation of annual rates of growth is seen for euro area: 1.8%, UK: 1.0%, Japan: 1.7%; the US sees 2% growth next year, with China recovering to 5.1%. The Russian economy is expected to contract by more than 10% this year. Turkish growth was marked up amid credit-fuelled recovery.

      A central risk to Scope’s economic baseline is further significant tightening of global financial conditions in the form of higher long-term bond yields, a further correction in global equity markets and/or appreciation of the US dollar. This could be the result of current very high inflation further surprising on the upside and/or behind-the-curve central banks tightening faster than currently communicated.

      “Faster policy tightening cuts the risk of inflation becoming more deeply engrained but also raises risk of policy mistakes exacerbating financial instability. Alongside significant Federal Reserve and Bank of England hikes and quantitative tightening, we expect the ECB to start raising rates for a first time this cycle later this week while introducing near term a novel ‘anti-fragmentation’ programme against rises of periphery spreads,” Shen said.

      Download Scope’s 2022 Sovereign Mid-Year Outlook (report).

      Watch our video explainer: Scope introduces the 2022 Mid-Year Economic Outlook.

      Finally, register for our webinar discussion: Global economy in slowdown: inflation, war, Europe’s energy crisis darken the outlook. Tuesday, 26 July at 15:30 CEST.

       

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