InterRegional for Strategic Analysis

Since late 2021, the world has experienced extensive inflation following far-reaching COVID-19 lockdowns and precautionary measures and the Russian military campaign in Ukraine launched in February 2022. These events have had broad social and economic consequences that prompted many governments to pour hundreds of billions into subsidies for businesses and households given the huge surge in fuel and food costs. These price hikes have been among the most serious repercussions of the Russian war in Ukraine.Ever since, inflation has spread through various other parts of the economy including housing and automotive sectors, which has led governments to adopt quantitative tightening policies to combat inflation and prevent interest rates and loan fees from rising further. During the last months of 2023, the headline inflation rate in many countries began to fall. However, in other countries inflation climbed even higher. This has raised questions about where inflation is headed in 2024, and which policies governments might adopt to grapple with inflation. Potential ScenariosBased on various current indices, the forecast for inflation in 2024 includes the following points:1. Lower consumer expectations for US inflation: According to a 5 January 2024 report on the most recent survey conducted by the Federal Reserve Bank of New York, US consumer expectations on short-term inflation had fallen by December 2023 to the lowest levels in about three years. Consumers expect an inflation rate of 3 percent by the end of the year, which is the lowest since January 2021. In November 2023, consumers had expected a rate of 3.4 percent. Survey participants expected inflation to be at around 2.5 percent in three years’ time compared to 3 percent as of November 2023.2. Projected drop in global inflation rates: In mid-2022, the annual Personal Consumption Expenditures Price Index showed inflation falling from a high of 7 percent in June 2022 to 3 percent in October 2023. The annual Consumer Price Index indicated that inflation was at 3.1 percent in November 2023.Inflation has begun to drop in most countries and the IMF expects global inflation rates to fall significantly to 5.8 percent in 2024, down from 6.9 percent in 2023. Inflation in GCC countries is also expected to return to pre-pandemic levels, following a series of spikes in interest rates during the last two years. Inflation is likely to remain around 2.3 percent in 2024, down from 2.6 percent in 2023. 3. Reduced prices for durable goods, food, and energy: Key supply restrictions are likely to be lifted for many goods, especially semiconductor markets, which will lead to a boom during the next few years after a period of major decline. The normalization of spending patterns—i.e., the return of increased spending on services—could also reduce pricing pressures on goods. Around a third of excess inflation on durable goods is expected to be overcome by 2027. Meanwhile, food and energy prices are also expected to drop as these sectors adapt to the upheaval arising from geopolitical factors such as the war in Ukraine.4. Housing sector inflation will persist during 2024: Inflation rates in the housing sector accelerated significantly during 2023, a trend that is expected to continue in 2024 due to the particular nature of housing market indices. These usually take a long time to become more favorable due to shifting market conditions. As a result, the cumulative impact of high market rents since 2021 will cast a shadow over the housing sector during the coming year.In 2024, it is possible that rents could see a marked slowdown in response to reduced housing demand and the increased supply of apartments. Annual rental growth was projected to fall to only 2.8 percent as of September 2023, down from 15 percent in April 2022. It is likely that lower demand for housing will affect housing prices, but housing prices will nevertheless remain constant and perhaps eventually approach pre-pandemic rates. This would lead to housing market indices returning to normal.5. A soft landing for inflation in the coming year: In 2023, inflation fell by 300 basis points as real GDP growth accelerated. This could challenge forecasts of stagflation, with some analysts arguing that serious economic stagnation will be necessary to resolve persistent inflation. However, in light of this more positive trend, it is now projected that inflation will likely return to normal in 2024. Some economists refer to this outcome as a "soft landing."6. Slight drop in annual headline inflation in the Eurozone: In the Eurozone, annual headline inflation fell to 3.4 percent in December 2023 from 3.6 percent in November. The stock market consequently began to climb, with the S&amp;P 500 on Wall Street and STOXX Europe 600 indices rising by 15 and 11 percent, respectively.However, inflation for consumer prices in the Eurozone rose to 2.9 percent in December 2023 from 2.4 percent in November 2023. Annual inflation rates increased in Germany and France, the two leading EU economies. In Germany, the consumer price index rose to 3.8 percent in December 2023, compared to 2.3 percent in November. In France, the annual consumer price index jumped to 4.1 percent in December 2023 from 3.9 percent in November, according to preliminary data. This was caused by rising energy prices and European governments rolling back generous household subsidies that had been provided during the energy crisis of 2022.7. Rising inflationary pressures on many developing nations: Recent escalations of global tensions, especially the war in Gaza and the conflict in Ukraine, could undermine growth in many developing economies. Forecasts indicate that growth will be around 3.9 percent in these economies in 2024, which is down by more than a percentage point from the average over the last decade.It is likely that low-income countries will experience 5.5 percent growth due to the impacts of current geopolitical events. This means that inflationary pressures will continue to increase in many countries with a sharp uptick in the price of goods and services. There could also be repercussions for the real estate and energy sectors.8. Inflation likely to fall in China: It is projected that the Chinese economy, the second largest in the world after the US, will grow by 4.6 percent in 2024, which is a significant drop from 5.2 percent in 2023. Recent data suggests that 2024 has had a tentative start with deflationary pressures continuing along with a slight increase in exports. This makes it unlikely that there will be a rapid shift in local economic activity. Inflation rates in China are likely to fall to around 0.1 percent in 2024.Policy ForecastsIn light of falling headline inflation rates in most G7 countries and major global economies, it is projected that policy makers will significantly reduce lending costs. However, this largely depends upon the degree of inflation in each country. Governments could pursue divergent policy approaches based on the specific circumstances of inflation in their countries. Comprehensive easing policies could become a global trend in 2024, with inflation on the decline. Some of the policies that states might adopt include the following:1. South Korea will hold interest rates constant: During the eighth consecutive meeting of the Bank of Korea on 11 January 2024, South Korea indicated that benchmark interest rates would remain unchanged at 3.5 percent. In South Korea, inflation fell until at least the third quarter of 2023. Inflation rates have now reached 3.2 percent, which is higher than the Bank of Korea’s target of 2 percent, while the South Korean won fell by 1.8 percent against the dollar. It is therefore unlikely that the Bank of Korea will change its strict stance, at least during the first half of 2024. Rhee Changyong, the governor of the Bank of Korea, gave a new year’s speech in which he indicated that the bank would pursue a combination of monetary policies during 2024 in order to mitigate inflation.Some economists expect the Bank of Korea to freeze interest rates and then ease its monetary policy a little during the second half of 2024. By that point, key inflation rates will have fallen to less than 2.5 percent, which will increase the need for monetary policies that support a "soft landing," or a gradual reduction of interest rates.2. European interest rates likely to drop during the second half of 2024: Given that key inflation rates fell to 3.4 percent in December 2023, it is likely that wage growth will stabilize in the first months of 2024. However, the full effects of the European Central Bank monetary tightening will continue to be felt this year. It is likely that inflation will fall in 2024 as a result of the bank’s tightening policies over the last two years.It is possible that falling inflation and limited growth will provide sufficient cause for the European Central Bank to lower interest rates by a total of 75 basis points each quarter, starting in June 2024, once the bank is certain that inflation is continuing to fall.3. GCC projected to ease monetary policies: Forecasts indicate that the non-oil sector will be a key driver of economic growth in the Gulf in 2024. This sector is therefore likely to grow 4 percent in the coming year, driven by positive momentum in the service and retail sectors. It will also be bolstered by strong liquidity, ongoing reform initiatives, and a rapid upsurge in private and governmental investment. Positive momentum is projected for Gulf economies in 2024, according to data from the purchasing manager’s index for the GCC. This measures business confidence and is a key index for the performance of the non-oil private sector. Due to these factors, some predict that Gulf monetary policies will ease by the end of 2024.4. Federal Reserve to continue tightening: In December 2023, the US Federal Reserve announced that it intended to maintain interest rates on federal reserve balances within the current targeted scope (5.25 to 5.5 percent). Markets expect to see reductions in benchmark interest rates in the latter half of 2024, as inflationary pressures fall.The increase in key US inflation rates above projected levels to 3.4 percent for the year ending in December 2023 (up from 3.1 percent in November) could give the Federal Reserve additional cause to keep lending costs at their highest levels in 22 years.It is worth noting that the Federal Reserve is currently concerned about declaring victory against inflation or ending the quantitative tightening policies of the last two years. The Federal Reserve feels that the policy of hiking interest rates needs to remain in place for a while until inflation is steadily falling. This was the view of the Federal Open Market Committee (of the US Federal Reserve), which met in December 2023.5. Bank of England set to approve reduced interest rates: It appears likely that the Bank of England’s quantitative tightening over the last two years will soon come to an end. The Bank of England is set to lower interest rates by summer 2024. However, the cumulative effects of high interest rates will continue to be felt, which means ongoing impacts on the housing sector and mortgage holders from interest rate hikes over the last two years. Interest rates are projected to drop in 2024 by 100 basis points, and ease the same amount in 2025.Economists at Goldman Sachs also predict that the Bank of England will lower interest rates more quickly than previously projected. This will soften that blow to households dealing with higher mortgage rates by a total of 11 billion pounds sterling.6. Bank of Japan ends decades of quantitative easing: The coming year is projected to be the first year of policy normalization for the Bank of Japan, which will end decades of quantitative easing. In 2024, strong wage growth is set to help the bank reach its long-awaited target of 2 percent stable inflation. Investment in new technologies is likely to expand further, drawing upon government subsidies and shifts in global supply chains.Given significant corporate profits in 2023, it is thought that wage growth could reach more than 3 percent in 2024. For the Bank of Japan, the first step in potential tightening of monetary policies is ending yield curve control programs that aim for a fixed yield for government bonds through buying or selling bonds in the open market, with the goal of keeping interest rates low. This step is likely to be taken during the first quarter of 2024, when the curve for Japanese government bonds dips below 1 percent. The Bank of Japan is then projected to raise interest rates by 10 basis points in the second quarter, but short-term rates will remain at 0 percent until the end of 2024.7. Interest rates set to fall in China: In light of deflationary pressures in the Chinese economy, some economists predict that the People’s Bank of China will pursue financial policies and measures in 2024 to combat these pressures and encourage lending. It is projected that the bank will lower interest rates for a year by 10 basis points to 2.4 percent. Meanwhile, policy makers will pump more funds into the financial system and reduce the amount of currency that Chinese banks can hold in reserve in order to bolster growth and mitigate risks of deflation.8. Developing economies could adopt comprehensive tightening: Some economies in the Middle East and Sub-Saharan Africa might be forced to maintain comprehensive tightening due to mounting inflationary pressures. This could result in currency losing value as the cost of goods and services surges out of control, and will require ongoing interest rate hikes or at least fixed interest rates without any reductions. If the region experiences geopolitical stability in the second half of 2024, these countries might catch up with global economies and reduce interest rates. However, that scenario depends upon various economic and political developments.In conclusion, many economies around the world will see inflation fall in 2024, as well as reduced interest rates and an easing of monetary policies. This will bring two years of quantitative tightening in many economies to a close, in what appears to be a positive turn of events as the global economy heads towards a better 2024. However, there are concerns about factors that could undermine this outcome due to unexpected geopolitical events and economic and political upheaval during the coming year. Such developments could thwart any potential openings to ease monetary policies, since government banks around the world must respond to economic conditions and the current state of inflation rather than hopeful forecasts.There are also economies in the Middle East and Sub-Saharan Africa that continue to experience rising inflation due to recent geopolitical events such as the war in Gaza, with its corresponding economic repercussions for the region. This could prevent these countries from catching up with advanced economies. While economies at the global level gradually move towards easing monetary policies, developing and impoverished economies will continue monetary tightening. Such measures will remain essential if economic and geopolitical upheaval continues.&nbsp;

How Will Governments Deal with Inflation in 2024?