The optimism for a soft landing and the global economy avoiding recession, as well as expectations of a continued drop in inflation, are fuelling asset valuations, however, inflation-driven risks remain amid patchy global economic recovery, the International Monetary Fund has said.
Stress in the banking sector that has rocked financial markets this year has subsided and equities, despite recent declines, have recorded year-to-date gains, the IMF said in its latest Global Financial Stability Report on Tuesday.
Risks to the downside, however, remain and an abrupt tightening of financial conditions can again test the resilience of the global financial system.
“While acute stress in the global banking system has subsided, a weak tail of banks remains in some countries," the IMF said. “In addition, cracks in other sectors may also become apparent and could turn into worrisome fault lines.”
Although the IMF’s growth forecast is skewed to the downside in the medium term, equities have rallied this year, despite sharp declines in stock prices since last month.
The gains were driven by rising long-term real rates and easing financial conditions in advanced economies.
“Taking a slightly longer view, so far this year stock prices in Europe and the US have climbed about 10 and 12 per cent, respectively, and corporate credit spreads remain near the lowest levels since the beginning of this rate hike cycle,” the IMF said.
“In Japan, equities have outperformed other advanced economies, supported in part by continued monetary policy accommodation and stronger corporate profits.”
The gains in emerging markets including Chile, Hungary, India, Mexico and Poland have been “notable”, consistent with the appreciation of most major emerging market currencies in the first half of the year.
The IMF on Tuesday maintained its forecast for the global growth this year but revised it down marginally for next, saying the world economy is on the path of recovery. However, growth remains slow and uneven.
Economic activity is below the pre-pandemic level, especially in the emerging market and developing economies. The pace of recovery is also divergent within different regions, the Washington-based fund said in its latest World Economic Outlook report on Tuesday.
The IMF has kept its global economic expansion forecast for 2023 at 3 per cent, below the 3.5 per cent expansion recorded last year, retaining the historical growth average of 3.8 per cent.
The fund estimates growth to hit 2.9 per cent next year, a 0.1 percentage point downgrade from the IMF forecast in July.
The fund said the prospects of the medium-term outlook were “dimming” as growth appeared weak, especially for emerging market and developing economies.
Global inflation is forecast to decline steadily, from 8.7 per cent in 2022 to 6.9 per cent in 2023 and 5.8 per cent in 2024. But the IMF has revised its projections higher for this year and next by 0.1 and 0.6 percentage points, respectively,
With core inflation still high and declining only slowly in many advanced economies, central banks may need to keep monetary policy tighter for longer than is currently priced in markets, the IMF said.
In emerging-market economies, progress on lowering inflation is more advanced, however, the widening divergence of inflation and economic outlook could mark the beginning of the desynchronisation of the global monetary policy”, the financial stability report said.
“Upside surprises to the inflation outlook would challenge this soft-landing narrative, resulting in a potentially sharp repricing of assets,” the report added.
The fund said that sustainable economic growth requires both price and financial stability and central banks must “remain determined” in their fight against inflation.
“There is tangible evidence that it is moving sustainably towards targets, although the stance of monetary policy should reflect a country-specific pace of economic recovery and disinflationary processes,” the report said.
“Central banks should be cautious not to ease policy rates too aggressively.”
Sovereign borrowers in emerging market economies, frontier markets, as well as the low-income countries should also boost efforts to contain risks associated with their debt vulnerabilities. They should initiate dialogue with creditors, seek multilateral co-operation, as well as support from the international community.
In China, policies to restore confidence in the real estate sector will be “critical to limit the risk of negative spillovers to the financial sector, corporations and local governments”, the IMF said.
“Priority should be given to facilitating the completion of housing projects, which could stem the slump in homebuyer sentiment, and the timely resolution and restructuring of troubled property developers.”
