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High inflation among the reasons for slower world economic growth: IMF

The world economy is likely to grow slower at 3.2 percent this year, and the IMF urges policymakers to prioritise addressing inflation

Inflation on the rise across the world

The International Monetary Fund has cut its global growth projections for this year and 2023, as it warns of a “gloomy and more uncertain” economy.

The world economy is likely to grow slower at 3.2 percent this year, the IMF said in its latest World Economic Update, before it hits 2.9 percent growth rate in 2023. April projections were at 3.6 percent.

The revisions were led by “higher-than-expected inflation worldwide, a worse-than-anticipated slowdown in China, and a worse-than-anticipated slowdown in China, reflecting COVID- 19 outbreaks and lockdown.”

The Washington-based lender urged policymakers to prioritise addressing inflation, even as tighter monetary policy could have real economic costs.

IMF said the risks to the outlook are “overwhelming tilted to the downside,” and if they materialise, “inflation rises further, and global growth declines to about 2.6 percent and 2.0 percent in 2022 and 2023, respectively, would put growth in the bottom 10 percent of outcomes since 1970.”

The IMF warns high inflation could lead to slow economic growth
International Monetary Fund Building In Washington, DC

The Washington-based lender then urged policymakers to prioritise addressing inflation, even as tighter monetary policy could have real economic costs.

“Targeted fiscal support can help cushion the impact on the most vulnerable, but with government budgets stretched by the pandemic and the need for a disinflationary overall macroeconomic policy stance, such policies will need to be offset by increased taxes or lower government spending,” the IMF said.

IMF’s outlook on the growth of economies in the Middle East and Central Asia have not changed from its April projections – still at 4.6 percent for 2022.

Here’s an overview of what experts have to say and how the UAE is combating the rising inflation:

A detailed look at inflation, what happened in the year so far, and what lies ahead

Record inflation triggers radical responses from central banks, pressuring activity and crushing all asset classes. It’s a regime shift and it’s not smooth, but we remain reasonably constructive, says Maurice Gravier, chief investment officer at Emirates NBD.

The first half of 2022 has simply been one of the worst in the history of markets. Today we’ll look back at what happened, and of course share our perspective for what’s next.

Back in January, our 2022 Global Investment Outlook was titled “Low Visibility Ahead”. Between high inflation, slowing growth, and the beginning of the end of magic money, we had more questions than answers for the year ahead. We were however not outright bearish, as we thought that the recovery still had legs, and that inflation was about to start normalising. Bottom-line, our key message was to expect volatility and to be more reactive than proactive.

A lot happened. The conflict in Ukraine: it amplifies inflation, especially through commodities, and it darkens the outlook for growth with the double-edged sword of sanctions for Russia. If that wasn’t enough, China went through a severe Covid outbreak and an even more severe response, which added pressure on global supply chains. The result: inflation hasn’t normalised, forcing central banks to go ballistic in fighting it at all costs.

Experts talk about the growing inflationary pressure and what it means for businesses
Maurice Gravier, chief investment officer at Emirates NBD

It’s important to point out – With no inflation for decades, central banks used to be markets’ best friends, supporting growth and financial stability. Things have changed. The battle against inflation is their existential mission, while the others have become secondary.

The Fed chairman said it is “unconditional” and the BOE governor said there are “no ifs and buts”. Price pressure is about high demand meeting constrained supply. Central banks can’t influence supply: their only tool is to make money more expensive to slow down activity and pressure demand. They have now raised rates at the steepest pace in recent history and withdrawn liquidity. Whatever it takes? Or whatever it breaks?

This is a terrible combination for investors. Inflation and higher interest rates directly affect bonds and pressure equity valuation multiples. Meanwhile, growth scare questions the trajectory of corporate earnings and the solvency of issuers. There is nowhere to hide: 2022 so far is a crash of everything, with every single segment of both fixed income and equity down between -15 percent to -20 percent.

So what’s next: stagflation?

Indeed, the June consumer price index in the US came out this Wednesday at an eye watering +9.1 percent year-on-year, an acceleration from May and a higher number than forecast. It means that the Fed could hike by more than 75 basis points later in July, which in turn will threaten growth further.

To that extent, the IMF cut its 2022 real GDP growth forecast for the US, from 2.9 percent to 2.3 percent, and expects only 1 percent next year. The European Commission did the same, trimming their projections to 2.6 percent this year and 1.4 percent in 2023. Are we about to hit the wall of stagflation?

Statistics: Inflation in the US rose by 9.1% in June
US inflation surged to 9.1 percent in June, leading to fall in global stock markets and euro dipping below $1 for the first time in 20 years

We don’t think so. These institutions are not known for their blissful optimism, and it’s worth noting that their revised growth numbers remain positive. So far, the global economy has been very resilient, with record low levels of unemployment in particular.

Of course, a recession is possible, especially in Europe, but we firmly believe that our inflation problem would also vanish under this scenario. And policy responses would dramatically change, especially given the stellar levels of debt in the system – not to mention political turbulence.

Crucially, lower valuations on all asset classes now discount a substantial economic risk – which could materialise, or not. Investor sentiments follow suit with record levels of pessimism: markets are not ready for good news, and it is interesting to see that after risk assets initially dropped when the US CPI came out, most recovered to close only slightly lower.

You have guessed it: we believe that the medium-term outlook is not adverse. Between base effects and central banks’ actions, inflation should start to normalise, but not to the 2 percent we were used to. Current levels are probably at their peak, which should halve at some point. That should be enough to justify a pause in tightening and providing relief to markets. The question is probably not if, but when.

Since the timing is the key unknown, we have two messages for the near future. First, volatility should remain extreme in the coming months – until we see the only true catalyst for sustainable market recovery, which is, again, convincing evidence that inflation is abating. We expect sudden and unpredictable corrections and rallies, which means that short-term speculation and leverage are dangerous games.

Second, the medium-term perspectives are reasonably constructive, as risks are adequately priced-in and sentiment is very pessimistic. We may be wrong of course, but we are prepared to increase exposure, should another severe correction happen.

This is the positioning we currently recommend in our tactical asset allocation. Cash doesn’t compensate for inflation, but it absorbs shocks and provides flexibility; we are close to neutrality. We are still underweighting fixed income, especially on its riskiest segments: some spreads are a bit complacent with the economic risk.

By contrast, government bonds are becoming more compelling: we have cut our underweight and recommend being opportunistic when rates overshoot. Within equities, we are neutral on developed markets but overweight on emerging ones – China has a very different dynamic as we discussed last month in this column. We also keep on favouring UAE stocks and find opportunities in India.

Finally, we overweight alternatives due to their very different sensitivities to both inflation and growth.

Maurice Gravier, chief investment officer at Emirates NBD.

Inflation bites into household budgets across the world

UAE residents brace for higher cost of living and continue to make cutbacks to their household spending as global inflation is forecast to reach 7.9 percent globally.

The vast majority, 83 percent, of UAE residents said their cost of living has gone up compared to 12 months back in the latest YouGov Realtime study.

As inflation bites into household budgets across the world, the top areas where UAE residents intend to make cutbacks are on eating out at F&B outlets (47 percent), clothes/apparels (43 percent).

Inflation causes UAE residents to reduce spending
Image: Shutterstock

The rising costs have made residents cut back on their spending with 40 percent spending less on gadgets and electronics, while 32 percent spend less on F&B takeaways and 27 percent on non-essential food items. Grooming services (26 percent), overseas holidays (25 percent), and leisure activities (25 percent) are also likely to take a hit in the upcoming six months.

Inflation in the Arab countries is expected to rise to approximately 7.5 percent in 2022, compared to 5.7 percent in 2021.

Despite steep costs, 39 percent of residents hope their financial situation to be better in the future compared to 21 percent who anticipate their financial situation to worsen and 27 percent expect it to remain unchanged.

The inflation rate is expected to witness a relative decline in 2023 to reach 7 percent, the Arab Economic Outlook Report adds.

In a bid to rein in inflation and avoid recession Gulf central banks raise interest rates

Central banks of the UAE, Bahrain, Kuwait, Qatar, and Saudi Arabia have raised their borrowing rates, following the same decision from the US Federal Reserve.

The Federal Reserve announced a consecutive 0.75 percentage point interest rate hike – in a bid to rein in inflation and avoid recession.

In the UAE, the central bank raised its benchmark base rate for its overnight deposit facility (ODF) by 75 basis point.

To rein in inflation the Central Bank of UAE has raised interest rates

“The CBUAE also has decided to maintain the rate applicable to borrowing short-term liquidity from the CBUAE through all standing credit facilities at 50 basis points above the Base Rate,” a statement on WAM said.

It added: “The Base Rate, which is anchored to the US Federal Reserve’s IORB, signals the general stance of the CBUAE’s monetary policy. It also provides an effective interest rate floor for overnight money market rates.”

According to central bank data, inflation in the UAE could reach up to 5.6 percent this year. Already in the first quarter, the consumer price index was up 3.4 percent compared with previous quarters.

The Saudi central bank announced a similar decision, raising its repurchase agreement rate by 75 basis points to 3 percent from 2.25 percent, as well as its reverse repurchase agreement rate from 1.75 percent to 2.5 percent.

The US move was the Federal Reserve’s fourth interest rate increase in four months, and its chairman Jerome Powell said any further hike in September would depend on data and hinted at slowing the pace of hikes.

“As the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases while we assess how our cumulative policy adjustments are affecting the economy and inflation,” he commented.

Inflation and economic downturn predicted by the IMF
US Federal Reserve Chair Jerome Powell. Image: Bloomberg

The Fed chairman added he did not think the economy was in recession, even though growth was negative in the first quarter.

“Think about what a recession is. It’s a broad-based decline across many industries that’s sustained more than a couple of months. This doesn’t seem like that now,” Powell said.

“The real reason is the labour market has been such a strong signal of economic strength that it makes you question the GDP data.”

Stocks rallied on Wednesday after the announcement and Powell’s comments. The Dow Jones Industrial Average jumped 436.05 points, or nearly 1.4 percent, to 32,197.59. The S&P 500 gained 2.62 percent to close at 4,023.61 and the Nasdaq Composite climbed 4.06 percent to 12,032.42.

Tech shares led gains a day after good quarterly results from Alphabet and Microsoft. It is expected to fall after Meta posted its first quarterly loss results on 28th July.

Shares in the Asia-Pacific region followed suit. The Kospi in South Korea was up 0.66 percent, while the S&P/ASX 200 was 0.43 percent higher in Australia. The Shanghai Composite gained 0.21 percent while the Shenzhen Component was 0.2 percent higher. Japan’s Nikkei 225 was flat.

While the fed funds rate directly impacts what banks charge for short-term loans, it also affects consumer products such as adjustable mortgages, auto loans and credit cards.

UAE introduces an inflation allowance for low-income citizens

The UAE is subsidising part of petrol prices for low-income citizens, as it introduces an “inflation allowance” amid rising costs of basic goods and services in the country.

The allowance, introduced in July will provide a monthly subsidy of 85 percent of the fuel price increase over AED 2.1 per litre, state news agency WAM has reported.

UAE combats inflation by introducing subsidies for citizens
UAE President Sheikh Mohamed bin Zayed Al Nahyan

The move is part of the UAE president’s directive to restructure its social welfare programme for low-income Emiratis, effectively doubling its size to AED 28 billion.

According to the new fuel subsidy scheme, the head of a family will receive a monthly subsidy of 300 litres, while working wives will receive a subsidy of 200 litres.

The inflation allowance will also provide food, electricity, and water subsidies, the report showed.

The government will bear 75 percent of food price inflation for eligible Emirati families, and will provide a monthly subsidy of 50 percent for specific electricity and water consumption quotas.

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