The decline in credit in 2022 and thus far in 2023 has little to do with credit supply. Rather, it reveals the effect of three years of COVID-19 restrictions and policy uncertainties on China’s psyche.

And while businesses’ appetite for long-term loans has surpassed levels of two years ago, we would expect even greater demand if the economy were healthy.

As pent-up demand that fueled a strong first quarter fades and external headwinds intensify, China will depend on improved household and business confidence to spur growth. And that may take time.

Look for more on China and the rest of the world in the midyear update to the Vanguard Economic and Market Outlook for 2023 scheduled to be released on June 26. 

The views below are those of the global economics and markets team of Vanguard Investment Strategy Group as of June 15, 2023.

Our 10-year annualized nominal return and volatility forecasts are shown below. They are based on the March 31, 2023, running of the Vanguard Capital Markets Model® (VCMM). Equity returns reflect a 2-point range around the 50th percentile of the distribution of probable outcomes. Fixed income returns reflect a 1-point range around the 50th percentile. More extreme returns are possible. 

Federal Reserve policymakers have put their interest rate hiking cycle on pause, leaving their target for short-term interest rates at a range of 5%–5.25%. But the Fed suggested that it could still hike interest rates by an additional 50 basis points before the end of the year.

The Fed’s updated views are consistent with Vanguard’s own view that the Fed has more work to do to bring inflation to acceptable levels and keep it there.

• The Consumer Price Index report for May revealed an easing of price pressures. Headline inflation rose by just 0.1% in the month on a seasonally adjusted basis, and by 4% compared with a year earlier. Although core CPI (which excludes volatile food and energy prices) rose by a greater-than expected 0.4% and was up by 5.3% year-on-year, private data suggest that prices for used cars and trucks, a leading contributor to core inflation’s gain, are set to fall in the months ahead.
• The U.S. labor market sent mixed signals in May. The economy created far more jobs than expected, but the unemployment rate rose from 3.4% to 3.7%. Average hourly earnings growth of 0.3% in May and 4.3% year-on-year was considerably higher than the Fed’s comfort level. With each month of labor market resilience, we see risks increasing that wage growth could become stuck at current levels.
• GDP grew at an annualized rate of 1.3% in the first quarter, according to a second estimate from the Bureau of Economic Analysis, higher than its first estimate of 1.1% but lower than the 2.6% growth in the fourth quarter.

Recovery is losing its steam after a strong first quarter driven by the economy’s reopening after COVID-19-related lockdowns. Vanguard has therefore lowered its forecast for full-year economic growth in China to 5.5%–6%, from our previous view of 6%–6.5%. The recovery has been skewed toward services, and we believe it has been front-loaded.

GDP increased by 4.5% in the first quarter compared with a year earlier, powered by consumers tapping into excess savings after COVID-19 lockdowns in 2022 and outstripping expectations.

“As pent-up demand fades and external headwinds intensify, growth will be contingent upon improvement in the labor market and income growth and a gradual recovery of household and business confidence, as well as additional policy support,” said Grant Feng, a Vanguard senior economist.

• With a clearer picture of China’s challenging fundamentals, the People’s Bank of China lowered the one-year medium-term lending facility rate from 2.75% to 2.65%. We expect further mild rate cuts plus targeted easing measures in the coming quarters, though we expect the magnitude of stimulus to be smaller than in previous easing cycles.
• Retail sales and industrial production data for May were below expectations.
• We have lowered our forecasts for both headline and core inflation for 2023 following a series of weak inflation prints driven by lower energy and pork prices and slowing economic growth. We foresee full-year headline inflation in a range of 1%–1.5%, down from our previous forecast of 2.5%, and core inflation of 1%, down from our previous forecast of 1.5%. 

The euro area tipped into recession in the first quarter, based on downward revisions to GDP data for the first quarter of 2023 and the fourth quarter of 2022.

Leading indicators suggest that the euro zone will grow modestly in the second quarter, making its energy-induced recession both shallow and short-lived. But we expect a double dip—a second recession following the first—later this year, though risks are rising that it could be pushed into 2024. The second dip would be driven by more restrictive monetary policy, namely the European Central Bank’s interest-rate tightening to quell inflation.

• The ECB raised the deposit facility rate by 25 basis points to 3.5%, reflecting its “updated assessment of the inflation outlook, the dynamics of underlying inflation, and the strength of monetary policy transmission.” We foresee the ECB raising its rate target by an additional 25 to 50 basis points in coming months, for a terminal rate of 3.75%–4%, and no rate cuts until mid-2024.
• There is tentative evidence that core inflation has peaked. We expect core inflation to average 4.5% in 2023, ending the year around 3.3%, still well above the ECB’s 2% target.
• The unemployment rate fell to a record low of 6.5% in the euro area in April, remained at 2.9% in Germany, Europe’s largest economy.

Persistent inflation underscores our view that the Bank of England (BOE) will need to raise the bank rate by another 25 or even 50 basis points, to 4.75%–5%, before ending the current hiking cycle that began in December 2021.

• Although headline inflation fell into single digits in April for the first time since August 2022, the 8.7% year-on-year increase exceeded expectations. The pace of core inflation accelerated to 6.8%, the highest annual increase since March 1992.
• “Inflation in the UK has been stickier than expected,” said Roxane Spitznagel, a Vanguard economist. “Although Vanguard expects both headline and core inflation to fall to just above 3.5% by the end of 2023 as more restrictive monetary policy takes hold, risks have increased that core inflation could stay higher.”
• We recently revised our forecast for 2023 GDP to no growth—from a previous forecast for a contraction of around 1%—as services demand and wage growth remain resilient.
• Our base case remains that a recession will take hold later this year, though the likelihood that it could be delayed in 2024 has risen substantially. 

The patterns and risks we’ve seen in developed markets over 2023 are like those we’re seeing in emerging markets: Economies have been resilient, and though inflation is slowing, it’s showing signs of stickiness in the services sector.

• Emerging markets led the global rate-hiking cycle, in no small part to defend currencies in anticipation of developed market rate hikes. We would expect emerging markets to lead a global rate-cutting cycle, too, but rate cuts may not be set in stone while inflation remains sticky.
• “We think inflation has peaked in Latin America and possibly in emerging Europe, too,” said Vytas Maciulis, a Vanguard economist. “But we expect only a gradual decline to levels that will give central banks confidence that they can begin to cut interest rates.”
• We recently upgraded our forecast for 2023 emerging markets growth from 3.25% to 3.9%, given China’s strong first-quarter growth and resilient activity globally. We foresee emerging Asia leading the way with 2023 growth of around 5.25%. We anticipate growth in Latin America of about 1.5%, and in central Europe, the Middle East, and Africa of around 1%. As in many developed markets, the chances are increasing that economic slowdowns could be delayed until 2024. 

When the Bank of Canada (BOC) surprised markets by raising its target for the overnight rate by 25 basis points to 4.75%, a 22-year high, it cited “surprisingly strong and broad-based” consumption growth, rebounding demand for services, and increased spending on interest-rate-sensitive goods. “Overall,” the bank concluded, “excess demand in the economy looks to be more persistent than anticipated.”

• Vanguard sees the BOC raising its overnight rate target further, to 5%, at its next policy announcement on July 12, with risks leaning toward a higher rate. “The idea that the Bank of Canada would resume its hiking cycle for a single rate increase seems unlikely,” said Asawari Sathe, a Vanguard senior economist. “It’s not like 25 basis points is a magic number that will halve inflation.”
• First-quarter economic growth that exceeded expectations no doubt played into the BOC’s stance. GDP rose by 0.8% in the first quarter and by 3.1% on annualized basis, Canada’s statistical agency reported. We continue to foresee 2023 GDP growth of around 1%, with risks to the downside, and a recession late in the year as the effects of higher interest rates spread through the economy.
• The pace of headline inflation increased in April for the first time since June 2022. The Consumer Price Index (CPI) accelerated to 4.4% compared with a year earlier, driven by higher rents and mortgage interest costs. The pace of core inflation edged down to 4.4% but remained well above the BOC’s 2% target.
• The labor market has shown some signs of softening, with the unemployment rate rising for the first time since August 2022, to 5.2% in May from 5.0% in April. 

Sticky inflation, an interest rate hike to the highest level in more than 11 years, and hawkish central bank comments have led Vanguard to raise its forecast for the Reserve Bank of Australia terminal rate to 4.6%. When increasing its cash rate target to 4.1% at its June meeting, the bank noted that, although inflation had passed its peak, “this further increase in interest rates is to provide greater confidence that inflation will return to target within a reasonable timeframe.” We don’t foresee the RBA cutting rates in 2023.

“Since the RBA’s June 6 decision, board members have struck a decidedly hawkish tone,” said Alexis Gray, a Vanguard senior economist. “They’re focusing on persistently high global services inflation, rising domestic housing prices, a weak Australian dollar, and potentially inflationary wage developments.”

• We expect headline inflation to fall to around 4.5% by the end of 2023, as higher interest rates dampen demand, and to fall to the RBA’s target band of 2%–3% in late 2024 or 2025.
• We expect the unemployment rate, which was 3.5% in May, to rise gradually this year to around 4% as financial conditions tighten and to continue rising in 2024.
• We are expecting GDP growth of 1%–1.5% for all of 2023, though risks are skewed to the downside. Our proprietary leading indicators model suggests that growth will fall below trend in the coming quarters amid weak consumer confidence and subdued consumption. 

• U.S. housing market has more—and more willing—buyers (article, issued June 2023)
• U.S. housing: Cyclical weakness, structural strength (article, issued June 2023)
• Why the Fed will not cut rates this year (article, issued June 2023)
• Lower interest rates this year? Not if the Fed respects history (guest column for Barron’s, issued May 2023)