Soaring inflation and how it will undermine global economic growth is capturing all the headlines right now.
After years of stability, inflation was down during the pandemic, with rates cratering to record lows in 2020 on concerns about COVID-19. Inflation started to climb significantly higher in 2021 on the heels of supply chain issues, strong demand, rising energy prices, and still record-low interest rates.
When the economy is doing poorly central banks, like the Bank of Canada and Federal Reserve artificially lower their key lending rate to encourage borrowing and spending. When the economy runs too hot, they do the reverse.
How Does Inflation Affect the Economy?
Here in Canada, inflation is sitting at a 31-year high of 6.7%. In the U.S., the world’s biggest economy, inflation hit 8.5% in March, its highest level since 1981. In Europe, which is the world’s largest economic region, inflation has soared to a record 7.5%.
This is forcing central banks from around the world to raise interest rates.
Rising interest rates in Canada, the U.S., and Europe will hinder borrowing, which will slow down economic growth and curb inflation. But rising interest rates could also slow the economy so much that a recession can’t be avoided.
To that end, the International Monetary Fund (IMF) cut its global economic growth projections for 2022 and 2023, citing Russia’s unprovoked invasion of Ukraine as being a major catalyst for the downgrade.
The IMF is now projecting a 3.6% GDP rate for the global economy in both this year and next. This represents a 0.8% and 0.2% drop from its January projections.
The World Bank, meanwhile, slashed its global GDP economic forecast for 2022 to 3.2% from a previous estimate of 4.1%. The World Bank noted that the Ukraine and Russian economies would face serious contraction which would impact nearby countries in Europe and Central Asia.
How Are Stocks Doing?
Not even a strong start to first-quarter earnings season can support Canadian and American stocks as investors digest signs central banks are ready to fight inflation with rising interest rates. For the week ending April 22, the S&P 500 fell 2.8% while the tech-heavy NASDAQ tumbled 2.8%.
After outperforming U.S. indexes for much of the past year, the TSX suffered its biggest percentage decline of the year on Friday, April 22, losing 3.1% for the week.
The TSX has been outpacing U.S. stocks because it is more heavily weighted to resource and other cyclical stocks that do well when the economy is performing well.
The decline points to darker times, which is backed up by growing concerns about a global recession by the end of 2022.
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First-quarter earnings season has been solid, but earnings are a snapshot of the previous quarter. Central banks are expected to jack up interest rates which could slam the brakes on the economy, which would undermine earnings and share price growth.
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