The Outlook is Worsening

By Professor Andrea Boltho, Kroll Real Estate Advisory Group Advisory
Board Member, and Emeritus Fellow, Magdalen College, University of Oxford.
July 2022
The world’s economic outlook is hardly improving. The last quarterly note stressed the dangerof a significant worsening in prospects, and unfortunately, this danger is materializing. Output
growth is decelerating almost everywhere, inflation is accelerating almost everywhere, thegrowth of world trade is slowing down and Russia’s war on Ukraine shows no signs of abating.
Fears of stagflation, or indeed, recession are now spreading across much of the world. The only
mildly good news is that the pandemic is in retreat. This success remains fragile given that newvariants may still emerge, but for the time being COVID is no longer having significant negative
effects on economic activity (with the partial exception of China - see below).
The headlines are dominated by inflation. This is now
approaching double digits in the U.S. and Western Europe
and is often above such rates in many countries in Eastern
Europe, the Middle East, Africa and Latin America (the onlymajor exception remains Japan). Most forecasts, however,expect inflation to return to much lower rates already nextyear. What justifies such optimism? One reason is thatsome of the recent upsurge in prices reflects transitory
increases that followed the deflation of 2020-21. More
importantly, there is yet little evidence of a wage-pricespiral which would be needed for inflation to becomeentrenched. Wage settlements have so far remained
relatively modest in many of the richer countries. This, inturn, will also contribute indirectly to the weakening ofinflation. Since real wages are often declining, so doespurchasing power, and this weakens demand pressures.
And a similar dampening of demand pressures comes fromthe sharp rises in interest rates that have alreadyoccurred and will be further pursued, particularly by
the Federal Reserve System, by the Bank of Englandand soon also by the European Central Bank (ECB).
While some cautious optimism may, therefore, bewarranted as far as inflation goes (but see below), thesame cannot be said for output growth. Falling purchasing
power and rising interest rates are depressing bothindustrial and consumer confidence. The U.S. seems
so far to be more affected than Western Europe given
the speed of its monetary tightening. The Eurozone,
however, could suffer as well should it impose a fulloil embargo on Russia or should Russia strengthen its
recently introduced policy of withholding gas supplies.
Energy shortages would further add to inflation andthe possible introduction of schemes to ration gas
this winter to industrial users (openly discussed nowin Germany and other countries) would, inevitably,affect output. Indeed, a full gas embargo by Russiawould almost certainly trigger a recession in Europe.
Even without it, the combination of earlier supply
shocks, very high debt levels and synchronizedmonetary policy tightening bodes ill for the future.
Within the Eurozone, Southern Europe is expected toperform relatively well this year thanks to a strong revival
in tourism. However, a potential problem for the Eurozone
is to be found in the reopening of interest rate spreads
between Germany and some of the Southern countries.
As the ECB raises interest rates, it will be unable tocontinue its policy of bulk buying government debt.
Italy is particularly at risk. The country’s potential growthrate is low, public- sector deficits are large, and the public
debt/GDP ratio is high. In addition, Italy is now facing arise in debt servicing costs and could, next year, have agovernment run by right-wing populist parties skeptical
about the euro and even the EU. Market pressures could
easily escalate and force Italy into unwanted austerity.
The ECB has promised to help avoid what it calls“fragmentation” (i.e., differences in monetary conditions
across the euro area), but its intervention, if it occurs, islikely to be subject to conditions that Italy may finddifficult to meet. Tensions, in other words, are resurfacing
and they could have negative effects on growth, notjust in the Southern Eurozone.
In the emerging world, China’s economic situation remains
quite robust. Inflation is relatively low, and Russia’s war on
Ukraine is having only a very marginal impact. But theso-called “zero-COVID-19” policy imposed by theauthorities is interfering with economic activity. The
appearance of infections, even if in very small numbers,
has led to draconian lockdowns of entire cities (Shanghai,
for instance, was almost completely shut for over onemonth). Given the easy transmissibility of the Omicron
variant, there is a danger that new or renewed city-wide
lockdowns could be imposed across the country.
Tentative estimates suggest that such policies could
reduce growth this year by 1 percentage point of GDP,
if not more. Elsewhere in the emerging world, thedifficulties are much greater. As in the developed world,
inflation is rampant because of soaring food and energyprices, only more so. In addition, rising U.S. interest rates
are weakening many currencies, adding to inflationarypressures and forcing countries to raise their own interestrates. Growth prospects have been sharply reduced.

Among the major economies at risk are Argentina,
Colombia, Egypt, Pakistan, South Africa, Turkey, etc.
And a further fear is that 2023 could see some countries
actually suffering from famines if the continuation of
the war in the Ukraine prevents the harvesting and theexport of wheat from that country and, possibly, also from
Russia. That, in turn, could lead to riots and political turmoil.
Turning to the real estate sector, low interest rates andsavings accumulated during the pandemic fuelled rapid
increases in residential real estate prices over the last
two years in many of the advanced countries. Sharply
rising interest rates and the expected growth slowdown(or recession) are bound to have the opposite effect incoming months. By next year, house price declines could
be widespread though the impending crisis will probably
not be as severe as the one that followed the Great
Financial Recession of 2008-2009. This would partly
reflect the spread of fixed rate mortgages, partly
healthier household balance sheets and partly also a
relative scarcity of accommodation following the shift inmany countries to remote working. The same, however,is unlikely to be the case for office buildings.
As was stressed in the last quarterly note, forecasts are atpresent surrounded by even greater margins of uncertainty
than usual. The table below shows projections whichassume that the war’s effects will last into mid-2023 but
also that inflation will gradually slow down in both the U.S.
and Europe. None of these outcomes are at all certain. A
prolonged war, for instance, would lead to negative growth
rates in Europe and zero growth in the U.S. in 2023.
GDP Growth Rates (%)
2020

2021

2022

2023

2024

Eurozone

-6.5

5.3

2.9

1.9

2.3

UnitedKingdom-9.3

7.4

3.5

0.8

2.4

UnitedStates-3.4

5.7

1.9

1.1

2.0

China

2.3

8.1

4.0

5.1

5.2

World-3.4

5.9

2.9

2.6

3.2

Source: Oxford Economics

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