Top 10 economic predictions for 2023

Below, we offer our top 10 economic predictions for 2023:

1. We expect COVID-19 to continue its transition to a global endemic and the status quo to prevail in Russia's war in Ukraine, with no material implications for the global economy.

Residual effects of the COVID-19 pandemic include episodic shortages that have complicated business planning and logistics and held prices higher than would otherwise have been the case. As the world moves into 2023 and continues the transition to an endemic, COVID-19-related shortages should become less frequent, helping prices in affected goods to ease further over the year.

Uncertainty around the course of the conflict in Ukraine remains and builds a premium into energy and other industrial commodity markets. We expect that the war in Ukraine will continue without major escalation through at least early summer, when a cease-fire may be achieved. That scenario will not end the conflict and economic sanctions and voluntary embargoes will remain. We do not expect renewed surges in commodity prices stemming from that conflict or the West's responses.

Looking ahead, softening global demand will be the dominant story and dampen inflation. While crude oil prices should ease over 2023, high energy costs will put a floor under the prices of processed materials and limit the decline in inflation.

2. Inflation will slow significantly in 2023, but achieving central bank targets will be a multiyear process.

After reaching multidecade highs in 2022, global inflation will moderate in response to tightening financial conditions, softening demand, and easing supply chain conditions.

Downward price pressures are already in the pipeline. S&P Global Market Intelligence's Materials Price Index, a comprehensive indicator of industrial commodity prices, has fallen nearly 30% from its record high in early March. Agricultural commodity prices are in the early stages of a correction and should decline through 2023, led by grain prices. Commodity price declines will filter downstream to intermediate and finished products, bringing some relief to businesses and consumers in 2023.

Yet, labor shortages and wage acceleration are contributing to the persistence of inflation, especially in services. In some sectors, such as machinery where price increases in 2022 did not keep up with input cost inflation, margin restoration will be a priority.

It could take several years to sustainably bring inflation rates down to central bank targets. Global consumer price inflation will likely ease to an average of 5% in 2023, finishing the year at a 3.5% year-on-year pace.

3. Global monetary policy tightening has further to go out heading to spring 2023 with much regional variation.

In the US, we expect the federal funds rate to peak near 5% next spring.

While the European Central Bank (ECB) moderated the size of its rate increases in December, its accompanying guidance was more hawkish than expected, suggesting the hiking cycle will continue well into 2023.

Many central banks in the region typically shadow ECB policy. The Bank of England (BoE) is an exception and faces US-style wage pressures. Still, with a recession already under way, recent fiscal tightening and concerns over a housing crash suggest the BoE will not go quite as far as the Fed. We expect a peak bank rate of 4% in spring 2023.

Monetary easing will likely begin earliest and be most pronounced in Latin America and emerging Europe. There, central banks tightened policy relatively early and substantially as inflation soared from 2021. We expect the Brazilian central bank to start lowering rates in mid-2023.

We do not expect the Fed to reverse course until it is confident that inflation will decline toward its 2% objective, implying rate cuts only from 2024 and disappointing futures market expectations of easing from late 2023. In broad terms, we see the same outlook for the ECB.

4. Mild recessions are forecast in the United States and Europe, but resilience in Asia Pacific will prevent a global recession.

In the US, persistently elevated inflation and extraordinarily tight labor markets have prompted a sharp monetary tightening that has resulted in higher Treasury term yields, wider spreads to yields on private bonds and mortgages, US dollar appreciation, a swoon in stock prices, a sudden reversal in house prices, and a notable increase in financial market volatility.

With a lag, and against the backdrop of waning pandemic-era fiscal relief, this broad and significant tightening of financial conditions will tip the US economy into a mild recession in the first half of 2023.

We forecast relatively short-lived and mild recessions in the EU/eurozone during the fourth quarter of 2022 and the first quarter of 2023, reflecting multiple headwinds and matching consistently with recent Purchasing Managers' Index™ (PMI™) data. The primary driver of expected real GDP contractions is private consumption given an acute squeeze on household real incomes due to exceptionally high inflation. A more severe, energy-driven recession will remain a potential risk beyond the current winter.

Asia Pacific is forecast to be the fastest-growing region of the global economy in 2023, acting as a counterweight to recessions in the US and the EU. This scenario reflects improving growth prospects in mainland China and continued economic expansion in other major Asia Pacific economies, including India and Southeast Asia. Australia, Indonesia, and Malaysia will continue to benefit from high commodity export revenues, particularly for oil, liquefied natural gas (LNG), and coal. Recessions in the US and the EU will dampen the region's economic performance since these economies purchase 27% of the region's exports.

Moderate expansions in Asia Pacific, the Middle East, and Africa will keep the global economy moving forward through 2023. Global real GDP growth is projected to slow from near 3% in 2022 to half that pace in 2023.

5. Housing markets will continue to weaken in the face of rising mortgage rates, but price declines may be tempered in some markets by still tight supplies relative to demographics.

In response to monetary tightening, mortgage rates will remain elevated through 2023. As a result, consumers who had previously locked in low rates will opt to remain in their current homes, and potential new homeowners will stay on the sidelines as purchasing a home is no longer affordable. Recession expectations and the cost-of-living crisis will further reduce demand and push prices lower in 2023, especially in overvalued markets.

We do not expect a market crash or full correction of price bubbles owing to the relative strength of labor markets. However, a need for even higher interest rates to counteract persistent above-target inflation or a significant increase in unemployment would increase the risk of a crash, leading to deeper and longer recessions. The highest risks are in Europe, the US, Canada, and Australia.

6. The US dollar has likely peaked and will retreat in 2023, but it will remain elevated compared with prior years.

Supported by favorable interest rate spreads and investors' flight to safety, the US dollar appreciated sharply over the first ten months of 2022, reaching unsustainable heights against the yen, the euro, and other major currencies before pulling back.

These forces will buoy the dollar through the first half of 2023. Subsequently, we expect the dollar to depreciate under the weight of large US current-account deficits and subdued economic growth.

The euro, which has weakened in response to the eurozone's vulnerability to the impacts of the Russia-Ukraine war and cautious monetary policies, will recover gradually. Meanwhile, some narrowing of US-Japan, long-term interest rate spreads and Japan's comparatively mild inflation rate will lead to some unwinding of the yen's sharp 2022 depreciation against the US dollar.

7. Emerging and developing economies (EMDEs) will remain resilient during 2023, but pockets of vulnerability will result in a two-tier growth path.

Higher interest rates in advanced economies, in combination with the expiration of most COVID-19 support measures in 2022, will have spillover effects for EMDEs.

The risks of higher default rates among domestic borrowers and sovereign debt restructuring have increased, but a wave of crises remains unlikely. Real GDP growth will be more vulnerable in EMDEs with slow policy responses, higher debt loads, and smaller external buffers, such as Zambia, Malawi, and Belarus.

The possibility of debt restructuring under the G-20 common framework, instead of disorderly defaults, is more likely for low-income, debt-distressed countries, especially in sub-Saharan Africa.

As a region, Asia Pacific has adopted more prudent policies since the Asian Crisis of the late 1990s and has more manageable debt levels and healthier external buffers. Asia Pacific will also benefit from lingering pent-up demand from the later lifting of COVID-19 lockdown measures, the resumption of pandemic-delayed infrastructure programs, relatively low inflation, and the modest recovery in mainland China's growth.

In contrast, emerging Europe will be severely affected by the slowdown in the eurozone and the continued impact of Russia's war in Ukraine.

8. Mainland China's easing of containment policies will propel a choppy economic recovery.

Given the likely outbreak waves in the wake of policy changes, the government will proceed to exit by balancing between alleviating public fatigue of containment measures and minimizing potential public health fallouts from the exit.

While financial markets may stage energetic rallies in response to the retreat of the policy, initial recovery of the real economy will be subdued, calling for accommodative economic policies to smooth the bumpy path.

9. Supply chain disruptions will ease markedly in 2023, but tensions from labor shortages will remain.

One of the lessons from the COVID-19 pandemic and its following recovery was that global supply was not geared to face the extreme demand shock that occurred upon the reopening of the world's major economies.

The recessions in Europe and North America that we anticipate in 2023 will help narrow the global supply-demand gap. That process has already started: S&P Global's PMI™ data show that global supplier delivery times in the manufacturing sector in November were down significantly from the peak in early 2022, with room to narrow further in some industries—equipment goods, mostly—as demand softens in 2023.

However, the easing of supply chain disruptions will likely be limited given labor shortages.

10. Labor shortages will remain a challenge in 2023 even as unemployment rates are predicted to rise modestly.

Economies that depended on migration for the provision of labor to keep their economies humming before the pandemic — the US, Canada, Western Europe, and Australia — will see migration flows improve, but probably not fast enough to head off capacity constraints.

In emerging markets, the wave of workers that moved from urban to rural areas during the worst of the pandemic will be slow to return, alongside a continued slow recovery of cross-country labor migration. Gulf Cooperation Council countries are an exception as migrants from East Africa and South Asia will remain crucial in supporting planned investments, given the insufficient local labor markets.

Another exception is emerging Europe — a significant share of Ukrainians and Russians who emigrated owing to the war in 2022 will remain abroad in 2023, boosting the population and potential labor force of other countries across Europe and Central Asia. Nevertheless, several countries face the risk of wage-price spirals amid skills mismatches and slow progress in containing inflation expectations.

Globally, hiring freezes will be more common than mass layoffs in 2023 as employers seek to retain talent. Job losses will be concentrated in sectors that are sensitive to credit conditions, such as real estate and finance.

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.