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

Inflation and the gas crisis, interest rate increases and the consequences of Corona, supply bottlenecks and the Ukraine war – the economy is struggling with many problems at the same time. How big is the risk of a recession?

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 hurricane looming on the economic horizon. “We just don’t know if it’s going to be a small one or a superstorm like Sandy,” he said. The World Bank recently again reduced its growth forecast for this year. At the World Economic Forum in Davos, World Bank boss David Malpass painted a bleak picture. “The world economy is in danger,” he said. “Many countries will not be able to avoid the recession.” Robert, Federal Economics Minister Habeck, also sees the danger of a global recession.

“World economy is in danger!”

It was originally expected that 2022 would develop into a boom year. Because of 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 percent. The federal government had forecast growth of 3.6 percent in January.

But the Ukraine war and the associated record high inflation, the gas shortage and the disrupted supply chains have abruptly halted optimism about the economy. In the meantime, economic research institutes and associations, governments and international organizations have lowered their forecasts one after the other and point to the risk of a recession under certain conditions.

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

Economist Jens Südekum, Professor of Economics at the University of Düsseldorf, predicts a severe recession in the event of a Russian gas supply stop. Because if no more gas came from Russia to Germany, the federal government would have to use the highest escalation level in the gas emergency plan. The Federal Network Agency would then control the distribution of the gas volumes that are still available. In this case, many companies are at least threatened with gas rationing and, as a result, production stops.

Fears of a harsh winter

The German economy narrowly avoided a recession in the first quarter. But the consequences of the war weren’t really felt then. In the second quarter, however, higher inflation, disrupted supply chains and the corona lockdowns in China are likely to have weighed more heavily on the economy.

In addition, consumption by private households as a pillar of the economy has failed. Consumer sentiment has recently deteriorated massively. If the situation does not improve in the third quarter either, Germany could slip into a technical recession. This is spoken of when economic output shrinks for two quarters in a row.

Recession in Europe is becoming more likely

Even if the already reduced Russian gas deliveries continue to arrive, Germany is threatened with a harsh winter. “The closer the cold season gets, the greater the risk of a recession,” fear experts. Many economists, investment strategists and top bankers are already preparing for a contracting European economy this year. A majority of fund managers expect a recession in Europe in the coming months.

Again and again, the consequences of the Ukraine war and the sharp rise in energy and raw material prices are given as reasons. “Europe is suffering the most from the economic and social effects of the war,” wrote the Organization for Economic Co-operation and Development (OECD) a few days ago. “Higher commodity prices are hitting countries around the world, adding to inflationary pressures, squeezing real incomes and spending and slowing recovery,” said OECD Secretary-General Mathias Cormann.

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

Turnaround in interest rates increases the risk of recession

The approaching 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 climb to 1.75 percent by the end of the year.

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

Fear of the hard landing in the US

Fed President Jerome Powell is not ruling out a recession. The supreme guardian of the currency wants to slow down the galloping 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 to the 1970s.

US President Joe Biden is more likely to tackle the increasing impoverishment of the population than to worry about the economy and the stock market, says Luca Pesarini from the fund company Ethenea. After all, the midterm elections are coming up in the fall. And he definitely wants to avoid a defeat.

US economic weakness would also hit Europe hard

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

And China has also recently lost its role as the engine that drives the global economy. Because of the zero-Covid strategy and the increasing lockdowns in metropolises like Shanghai, the economy is likely to grow less strongly this year than in 2021. The country’s communist leadership recently presented a 33-point program to boost the economy. Officially, economic growth of around 5.5 percent is currently being targeted for the current year.

However, the lockdowns 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 USA and the EU more difficult. Orders can often only be processed with a delay or sometimes not at all because parts are missing. Accordingly, the situation in China is helping to slow down 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, shortages of parts and threats to the energy supply as a result of the Ukraine war. 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 for further growth are in place,” said ECB President Christine Lagarde a few days ago. A recession is not part of the ECB’s baseline scenario.