Bad news for central bankers

The global economy is showing vigor, with business surveys this week pointing to a widespread revival in growth despite rising borrowing costs and elevated energy and food prices, a sign that central banks may need longer than anticipated to bring inflation under control.

Data from the U.S., China and Europe have shown surprising vitality in these regions’ economies since the start of 2023, confounding predictions from the World Bank and other economists that the global economy was set for one of its weakest years in recent decades.

While this is promising for governments, that resilience may persuade central bankers that they need to raise key interest rates further than anticipated to cool prices—effectively pouring more cold water on an economy that is still running a little too hot. This could translate into a slowdown in growth later in the year and into 2024, which had been seen as a recovery year.

A key indicator for central banks is the jobs market, which remains tight in many parts of the world. Policy makers have been scrutinizing labor market data for hints of rising unemployment, a drop in hours worked, or a slowdown in wage rises—all of which could help cool demand and ease upward price pressure but remain elusive.

“We’ve seen central banks raise rates,” said Madhavi Bokil, an economist at Moody’s Investors Service. “The hope is that with a few more rate rises that will be enough. If it isn’t, we could see them raising rates even further.”

The most recent signs that growth has been stronger than was expected at the turn of the year came in recent factory surveys around the world from S&P Global.

In February, these showed the first rise in global manufacturing output in seven months, aided by a jump in China after authorities lifted stringent Covid restrictions. Similar surveys of service providers around the world point to an acceleration in growth, including in China and Europe.

Inflation rates are also proving stickier than expected.

In the U.S., inflation firmed and Americans’ spending and income surged in January, according to the Commerce Department. The Fed’s preferred inflation gauge—the personal-consumption expenditures price index—rose 5.4 percent in January from a year earlier, while U.S. consumers’ spending jumped a seasonally adjusted 1.8 percent in January from December, the largest increase in nearly two years. Wages and salaries grew 0.9 percent in January, more than twice as fast as in the prior month.

Europe has also started the year with a burst of energy, and seems unlikely to slide into the recession forecast by many when energy prices surged in the months following Russia’s invasion of Ukraine. The cost of that health: Data out Thursday showed the core rate of inflation—which excludes oil and food—hit a record high in February.

China’s revival has helped boost factory production in other parts of Asia. But economists are cautious, in part because of uncertainties as to how much—and how soon—China’s reopening will benefit the rest of the region.

The ditching of strict pandemic curbs in China will mostly benefit consumption, potentially a boon for countries like Thailand that are popular among Chinese tourists, according to Trinh Nguyen, senior economist at Natixis in Hong Kong.

However, outbound flights from China remain limited and the positive impact from spending among Chinese tourists likely won’t be obvious until the second half of this year.

“China’s recovery is good for itself and particular sectors, but it isn’t good for everyone in the rest of the region,” said Ms. Nguyen. “It is not the tide that lifts all boats.”

There are also doubts about how resilient growth in the U.S. and Europe is likely to be. After all, interest rates have already risen very sharply by the standards of recent decades, and it can take time for the full impact to be felt.

“It simply takes months before tighter monetary policy finds its way into the real economy,” said Carsten Brzeski, ING Bank’s chief economist. “And it will. Or put differently, if the greatest monetary policy turnaround in years does not leave any marks on the real economy, we could also close all central banks.”

An alternative explanation for such surprising resilience in the face of what appear to be aggressive central bank moves is that interest rates only gain traction at a certain level.

Mark Dowding, chief investment officer at RBC BlueBay Asset Management, suggested rates might “need to move above a threshold such as 2 percent before they start to have any effect whatsoever.”

“If that were the case, then we could suggest that the U.S. hiking cycle only really started six months ago and in Europe, it is only just getting under way,” he added.

The strength of the U.S. economy could prompt the Federal Reserve to raise interest rates higher than previously anticipated this year to cool price pressures. The same holds for the European Central Bank: Following the jump in eurozone core inflation, economists at Barclays raised their forecast for the central bank’s key interest rate, and now expect it to reach a record high over coming months.

For as long as central banks remain determined to bring inflation down to their targets, any sign of economic strength seems likely to trigger a policy response intended to snuff it out.

So while Moody’s on Tuesday raised its growth forecasts for the U.S. and Europe, it still expects a slowdown this year, to 0.9 percent and 0.5 percent, respectively.

The fallout of further monetary policy tightening won’t be limited to those regions. It is likely to hit developing economies, some of which—notably Brazil—raised their key interest rates earlier and have seen inflation cool since. When the U.S. central bank raises rates, emerging markets’ borrowing costs often rise, their currencies fall and their exports weaken.

“For central banks, the only message from the recent acceleration in growth and inflation can be that their tightening thus far hasn’t sufficed,” said Christian Keller, chief economist at Barclays.