Many risk factors: How big is the risk of a recession?

Status: 06/24/2022 12:43

Inflation and the gas crisis, rising interest rates and the aftermath of the Crown, supply bottlenecks and the war in Ukraine – the economy is grappling with many problems at the same time. How big is the risk of a recession?

By Notker Blechner,

The R word is back. More and more economists and stock market professionals are sounding the alarm and warning of an impending recession. Jamie Dimon, head of the world’s largest bank JP Morgan, recently warned of a looming hurricane on the economic horizon. “We just don’t know if it’s going to be a small storm or a super storm like Sandy,” he said. The World Bank recently reduced its growth forecast again for this year. At the World Economic Forum in Davos, World Bank chief David Malpass painted a grim picture. “The world economy is in danger,” he said. “Many countries will not be able to avoid the recession.” Robert, the federal minister of economics Habeck, also sees the danger of a global recession.

“The world economy is in danger!”

2022 was initially expected to turn into a boom year. Due to the waning corona pandemic, economic research institutes initially predicted economic growth of three to four percent for Germany. The Federation of German Industries (BDI) had assumed an increase of 3.5%. The federal government had forecast growth of 3.6 percent in January.

But the war in Ukraine and related record inflation, gas shortages and disrupted supply chains have abruptly put an end to optimism about the economy. Meanwhile, economic research institutes and associations, governments and international organizations have lowered their forecasts one after another and point to the risk of a recession under certain conditions.

If the gas supply fails, there is a risk of a severe recession

Economist Jens Südekum, a professor of economics at the University of Düsseldorf, predicts a severe recession if Russian gas delivery is disrupted. Because if no more gas comes from Russia to Germany, the federal government would have to use the highest escalation level in the gas contingency plan. The Federal Networks Agency will then monitor the distribution of the gas volumes still available. In this case, many companies are at least threatened with gas rationing and, consequently, with production shutdown.

Fears of a harsh winter

The German economy narrowly avoided a recession in the first quarter. But the consequences of the war didn’t really make themselves felt then. In the second quarter, however, rising inflation, disruption of supply chains and the freezing of the crown in China are likely to have weighed more on the economy.

Furthermore, private household consumption as a pillar of the economy has failed. Consumer sentiment has recently worsened massively. If the situation does not improve even in the third quarter, Germany could slide into a technical recession. This is talked about when economic output falls for two consecutive quarters.

Recession in Europe is becoming more likely

Even as the already small Russian gas deliveries continue to arrive, Germany is threatened by a severe winter. “The closer the cold season approaches, the greater the risk of a recession,” experts fear. Many economists, investment strategists and prominent bankers are already preparing for a shrinking European economy this year. Most fund managers expect a recession in Europe in the coming months.

Again and again, the consequences of the war in Ukraine and the sharp rise in the prices of energy and raw materials are cited as reasons. “Europe is suffering the most from the economic and social effects of war”, wrote the Organization for Economic Cooperation and Development (OECD) a few days ago. “Rising commodity prices are affecting countries around the world, increasing inflationary pressures, squeezing real incomes and spending and slowing the recovery,” said OECD Secretary General Mathias Cormann.

“The risk has increased that economic output in the euro area will decline for a few quarters with initially high inflation,” says Holger Schmieding, chief economist at Berenberg. Deutsche Bank chief Christian Sewing sees the likelihood of a global or European recession at 50%.

The reversal of interest rates increases the risk of recession

The imminent turnaround in interest rates in Europe could further fuel the risk of recession. In July, the European Central Bank (ECB) plans to raise interest rates for the first time in a long time. Interest rates could rise to 1.75% by the end of the year.

The United States shows how much interest rate hikes are blocking the economy. GDP fell by 1.5 percent in the first quarter. If the decline continues into the second quarter, the US could already slide into a recession.

Fear of hard landing in the United States

Fed Chairman Jerome Powell is not ruling out a recession. The supreme guardian of the currency wants to slow runaway inflation with a wave of interest rate hikes. To do this, he accepts an economic downturn. Many economists accuse him of damaging the economy with an overly aggressive interest rate policy. Some even draw parallels with the 1970s.

US President Joe Biden is more likely to address the growing impoverishment of the population than to worry about the economy and the stock market, says Luca Pesarini of fund firm Ethenea. After all, mid-term elections are coming in the fall. And he absolutely wants to avoid defeat.

The economic weakness of the United States would also hit Europe hard

Even a long period of weakness in the US economy or even a prolonged recession would hit Europe hard. A recession in the eurozone would therefore be likely, says Berenberg economist Schmieding. It is therefore very important for Europe whether the US can achieve a soft landing.

And China has also recently lost its role as the engine that drives the global economy. Due to the zero-Covid strategy and growing lockdowns in metropolises like Shanghai, the economy is likely to grow less strongly this year than in 2021. The country’s Communist leadership recently unveiled a 33-point program to revive the economy . Officially, economic growth of around 5.5% is expected for the current year.

However, blockages in China are not only affecting production there, they are also leading to container ship congestion and significant delays in global supply chains. This also makes the work of many companies in the US and the EU more difficult. Orders can often only be processed with a delay or sometimes cannot be processed at all because parts are missing. As a result, the situation in China is helping to slow the global economy.

So the list of risk factors for the global economy is currently long: interest rate increases on the one hand and rapidly rising prices on the other, disrupted supply chains, component shortages and threats to energy supply due to of the war in Ukraine. The fact that a recession is imminent if one of these factors develops unfavorably has been clearly stated in most economic forecasts for months. However, it is by no means certain that this will actually happen. “The conditions are in place for further growth,” said ECB President Christine Lagarde a few days ago. A recession is not part of the ECB baseline scenario.

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