29.04.2024. Three dangers to economic recovery, Lithuanian Echo

Vytenis Šimkus, Swedbank Senior Economist

This year brings the hope of faster economic recovery. The energy price shock has died down and inflation is receding, thus reviving the purchasing power of the population. There is a growing belief that central banks are about to start cutting interest rates. Business and population expectations are improving, and many asset classes are recording positive results. The industrial sector, which has spent the past year in recession, is sending increasing signals of recovery. All the conditions seem to be in place for a soft landing and a quick economic recovery. However, as always, there are risks that can confound good predictions.

The Fed may not cut interest rates

The US economy seems unstoppable. Although early indicators warned of an impending recession, the American economy gained more momentum. Last year, the US budget deficit increased from 3.7 to 8.2 percent. GDP, and such a huge injection of money stimulated both consumption and greater investment in industrial development.

On the other hand, strong domestic demand means more pressure on prices. Inflation in the US is decelerating more slowly than in Europe and is unlikely to reach 2% in the near future. purpose. If inflation continues to remain relatively high, the Federal Reserve Bank (FED) may decide that further interest rate cuts are unnecessary. The longer interest rates remain high, the more likely financial stress will become more apparent.

Many companies hoped to wait out the period of high interest rates and refinance their debt when interest rates fall, but this is becoming increasingly difficult and the financing burden is steadily increasing. Meanwhile, the residential and commercial real estate markets remain frozen. So far, the US economy has shown great resistance to high interest rates, but over time the impact of tight monetary policy will strengthen, especially considering that fiscal policy will no longer stimulate growth this year.

Increasing competition from China

China aims to reach more than 5 percent this year. GDP growth. The challenge is indeed complex as its real estate sector remains in deep recession. Therefore, the Chinese economy will need a lot of fiscal and monetary stimulus measures. Unfortunately, China refuses to seriously stimulate domestic consumption, even though it would be a balanced path to further growth. Instead, China is rapidly expanding production capacity and subsidizing production.

On the one hand, this leads to lower global commodity prices, but it also leads to intensified competition due to limited global demand. Cheap Chinese electric cars and electronics are flooding the markets and putting European, Japanese or South Korean entrepreneurs in a rather awkward position. Such a Chinese strategy could lead to a weaker-than-expected export recovery in the Western world, or lead to protectionism and trade wars.

Belts that are too tight can interfere with blood circulation

Inflation in Europe is consistently decreasing, so it is almost certain that the European Central Bank (ECB) will start easing monetary policy already in June. However, threats may arise from fiscal policy. Since this year, the EU’s fiscal discipline rules have come into effect again, due to which many member states should start reducing their public finance deficits.

Unfortunately, these rules go far beyond the economic reality, which requires greater investments in energy and defense. A significant number of member states may choose not to cut costs and invest in strategic areas, and this could provoke a conflict with the European Commission. in 2011 similar premature belt-tightening led to a debt crisis in Europe that delayed economic recovery for a long time.

Last time, tiny Greece was at the center of the crisis, and austere Germany’s voice was much stronger. At this point, conflict is most likely due to excessive spending by France and Italy. The economic weight and political influence of these countries are incomparably greater – the euro zone cannot exist without these countries. This means two things: either the fiscal rules will not actually be enforced and belt-tightening will be only on paper, or we risk a much more serious debt crisis than we have seen in the past decade.

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