Stubbornly high inflation in the United States and Europe will lead to a further tightening of global financial conditions and increased recession risks later this year and early next year. This will translate to a deterioration of the economic outlook for countries around the world (especially those in Latin America), as well as the financial outlook for highly-indebted countries (especially those in Africa), though Asian countries will be less impacted thanks to the spillover effects from China's economic rebound. High post-COVID and Ukraine-related inflation has forced the U.S. Federal Reserve and the European Central Bank (ECB) into substantial monetary tightening over the past year. Although headline inflation seems to have peaked, the Fed and the ECB's rate hikes have not yet had a strong enough impact on economic growth to further reduce inflation. The U.S. economy registered two quarters of negative growth in early 2022, but has rebounded during the second half of the year. The euro area economy, meanwhile, has avoided an outright recession. Against the backdrop of continued tight labor markets, core inflation has remained unexpectedly high — portending significant further interest rate hikes that will increase the risk of a recession or at least a sharp slowdown of economic growth in both Europe and the United States in late 2023 and early 2024. 

• Inflation in the United States reached a 40-year high of 9.1% in June following a strong surge in post-COVID consumer spending, supply chain problems, and skyrocketing energy prices related to Russia's war in Ukraine. Euro area inflation peaked at 10.6% in October.
• Since mid-2022, the Fed and the ECB have raised their main policy rates by a cumulative 450 and 300 basis points, respectively.
• Labor markets rebounded strongly in 2022 after the United States and Europe began widely lifting COVID-19 restrictions, and have kept upward pressure on wages ever since. At 3.5%, U.S. unemployment is near 50-year lows. At 6.7%, EU unemployment is also at historical lows.
• Headline inflation in Europe and the United States has declined, but it is declining more slowly than expected, while core inflation remains way above the inflation target. U.S. consumer price inflation declined to 6.4% in January from the recent peak of 9.1% in June. U.S. core inflation has only fallen to 5.6% in January from its peak of 6.5% last March. Euro area inflation fell to 8.5% in February from 10.6% in October. But core inflation in the eurozone has actually increased to 5.6% from 5.0% during the same period.

In the United States and Europe, a normalization of post-COVID domestic demand and tighter financial conditions have helped bring headline inflation under control. But prices aren't falling fast enough, which will force the Fed and the ECB to further tighten monetary policy. The Fed and the ECB — the world's two most important central banks — are implementing hawkish policies to cool labor markets and wage inflation. But while headline inflation in Europe and the United States has declined, it is declining more slowly than expected, while core inflation remains way above the inflation target. For inflation to fall more sustainably, higher interest rates will need to substantially weaken the labor market and increase unemployment. The Fed and the ECB would ideally like to lower inflation without severely deteriorating labor market conditions, given both banks' dual mandate of price stability and maximum employment. Historically, however, this has been difficult to do. The Fed and the ECB are thus more likely to over-tighten and dip their economies into recession while increasing unemployment.

• According to its latest World Economic Outlook published on Jan. 30, the International Monetary Fund now expects U.S. real GDP growth to slow to 1.4% in 2023 (down from 2.0% in 2022) as the policy rate hikes work their way through the economy. The IMF's outlook for Europe is even grimmer, with the institution expecting the euro area economy to only grow 0.7% this year (down from 3.5% in 2022).
• The Fed is poised to raise its policy rate to (at least) 5.25-5.5% (from the current 4.5-4.75%) by the middle of the year amid stubbornly high inflation. The ECB's policy rate is also forecast to reach (at least) 4.0% (up from the current 2.5%) by the middle of the year. 
• 60-70% of economists said they expect the United States to enter a recession in 2023 in a December poll conducted by the Financial Times.

In terms of the global outlook, accelerating Chinese economic activity will somewhat offset the increased risk of a U.S. and European recession in late 2023 and early 2024. In Asia, China's recent economic rebound following the lifting of its strict ''zero COVID'' lockdown measures in December will support regional growth, helping shield China's neighbors and top trade partners from the West's economic downturn. For Africa, the impact of shifting global growth dynamics will also largely be neutral due to China's growth acceleration, which — combined with falling food and energy prices — will offset the drag from lower advanced economy growth as well.

• In its latest World Economic Outlook, the IMF slightly upgraded its forecast for global growth, which is now expected to reach 2.9% this year (up from IMF's previous 2023 growth forecast of 2.7%).
• According to the IMF, China's real GDP growth is also projected to rebound to 5.2% in 2023 (up from 3% in 2022) amid the country's post-COVID economic reopening. The IMF expects Asia's economic growth to reach 5.3% in 2023 (up from 4.3% in 2022) as well. 
• The IMF expects sub-Saharan Africa's 2023 economic growth to remain largely unchanged from last year at around 4%. 

But slowing economic growth in the United States and Europe, combined with a further tightening of global financial conditions, will still make for a challenging economic and financial environment — particularly for Latin American countries and highly indebted developing economies in Africa. The United States and Western Europe's slowdowns will weigh most heavily on the economies of their main trading partners in Latin America and Eastern Europe. Lower global energy prices will also slow economic activity in oil-producing countries in the Middle East. More broadly, low-income countries around the world will continue to face the greatest economic and financial stability challenges due to high debt levels, as well as high and rising debt servicing costs. This is especially true for highly indebted countries borrowing in foreign currencies, as a stronger U.S. dollar (and weaker local currency) means that dollar-denominated debt will translate into heavier real debt burdens. A simultaneous economic downturn in the United States and Europe may also drag down global commodity prices, or at least put a lid on price increases — further diminishing the foreign-currency revenues of commodity-export-dependent economies, particularly in Africa. Middle-income countries will also experience some challenges, but their economic and financial situation will remain manageable. This is because most middle-income countries have manageable external debt levels and flexible exchange rates, and have also accumulated sufficient foreign-exchange reserves, which will enable them to adjust to tightening global financial conditions more readily than in the past. 

• According to the IMF's latest global economic forecast, Latin America's real GDP growth is expected to fall to 1.9% in 2023 (down from 3.9% in 2022). In the Middle East and Central Asia, economic growth will decline to 3.2% in 2023 (down from 5.3% in 2022).