The IMF says the worst is yet to come – and for once, I agree

The world economy is taking a beating, and things will get worse before they get better. More or less wherever you look, the news is glum, and the problem, as always at a moment like this, is to sort out what is really new and important and what is just the usual noise.

There is, however, no question that this sour mood increases the chances of a global recession in the coming months, and we have to deal with the world as it is rather than as we might wish it to be.

The mood was summed up in a paper by the Brookings Institution, the respected Washington think tank, in a briefing paper that caught the feeling of general despair. “A series of self-inflicted wounds,” it said, “ranging from China’s zero-Covid policy to the United Kingdom’s fiscal recklessness, piled on top of persistent supply chain disruptions and the protracted war in Ukraine, have severely constricted space for policy manoeuvre.”

I think it is a bit rough to bracket the policies of Kwasi Kwarteng with those of Vladimir Putin and Xi Jinping, but Brookings is right in saying that governments and central banks can’t do much to ease current pressures. The grind of higher interest rates, led by the US Federal Reserve, is increasing the cost of borrowing for every government in the world, and every company or mortgage payer too. More expensive financing will certainly curb economic growth and quite possibly push several big economies into recession next year.

The new forecasts from the International Monetary Fund actually show the UK having decent growth of 3.6 per cent this year, but falling to 0.3 per cent in 2023. Both the German and Italian economies are expected to decline next year, though the US, France and Japan should eke out some growth.

There are so many moving parts that it is most helpful to sort these out into their different pots, and first, the special position of the UK.

Here, there is considerable confusion and that will continue through the autumn and winter. The next financial statement, with tax changes and economic impact certified by the Office for Budget Responsibility, is now due on 31 October. But we will have to wait for the Budget in the spring, assuming Kwasi Kwarteng is still in office, before things will settle down. Meanwhile, we had the Bank of England being forced to intervene in the gilt market yet again on Tuesday to take pressure off pension funds that might otherwise be forced to sell stock.

There has been a thumbs down from the independent Institute for Fiscal Studies, calculating that there will be a £60bn hole in the government’s finances if it goes ahead with its proposed tax cuts. The rating agencies, including Fitch, have warned of a downgrading of UK creditworthiness. Analysts from Goldman Sachs think the pound will go on weakening against the dollar. Indeed, the only positive signal I have seen anywhere comes from Jamie Dimon, head of JP Morgan Chase, saying that Liz Truss should be “given the benefit of the doubt” as “new governments always have issues”.

At any rate, the result is that the yield on 10-year gilts is currently a bit under 4.5 per cent, while the equivalent rate on US treasuries is 3.9 per cent. Rates are going up everywhere, but whereas back in August, Britain could borrow more cheaply than America, now it has to pay more. When it made its intervention in the gilt market, the Bank of England warned of a “material risk” to UK financial stability. This is not good.

However, the plight of the UK is only one element of the wider troubles in the markets and there are other places where stress from the seemingly inexorable rise in interest rates is breaking out. For example, the US housing market is very weak, as you might expect with new mortgages costing 7 per cent. That has knock-on effects, for example on the share price of Redfin, the technology-driven real estate company. Its shares are down 87 per cent so far this year.

In Europe, the climb in rates is at an earlier stage than in the US and UK, with the European Central Bank’s deposit rate only 0.75 per cent. Some countries, including the Netherlands where inflation is now 17 per cent, are pushing for faster increases through the rest of this year.

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The point here is that when there are sudden movements in asset prices, there are always unforeseen knock-on effects. People expect big swings in equity markets, but they don’t expect similarly jagged movements in bond markets. The problems that have come to light in the UK pensions industry will be the canary in the coal mine, warning of greater disruption elsewhere.

The final area of uncertainty is the threat of further physical shocks to the world economy from the current war in Ukraine, and maybe other conflicts that will break out in the months ahead. It is difficult to say anything sensible about this, except to observe that in uncertain times investors switch their resources towards the US.

Money is cowardly and the world’s largest economy is the greatest safe haven for frightened funds. This will not always be the case. There have been times in the past when the dollar has been far lower. The Federal Bank of St Louis keeps a tab on its trade-weighted value here and the dollar at an indexed value of 127.6 is higher than at any time since that index started in 2006. In the financial crisis of 2008, it went down to 86.

Of course, calm will return and the world economy will recover. But my guess is that the upturn comes in 2024, and we have to get through next year first. According to the IMF, the worst is still to come – and for once, I agree.