[Global Economic Outlook] US Interest Rate Expected at 5.25% in Q2 Next Year... Inflation Deceleration Slows Down

Next year, the global economy is expected to see a slower-than-anticipated decline in inflation rates as countries maintain high levels of long-term government bond yields and the strong US dollar persists, according to an analysis by a national research institute. International oil prices are forecasted to remain high for the time being due to supply uncertainties stemming from the Israel-Hamas war and the reduction of US strategic petroleum reserves.

According to the '2024 Global Economic Outlook' report released on the 14th by the Korea Institute for International Economic Policy (KIEP), South Korea is likely to experience a more gradual slowdown in inflation rates than initially expected next year due to prolonged monetary tightening in major countries, increased volatility in international oil prices, and the ripple effects of exchange rates. This suggests that the tightening trend may last longer than anticipated.

"Inflation slowdown trend remains valid... but will exceed target levels"

The report forecasts that the US long-term government bond yields will remain at a high level in the 5% range until the first half of next year. According to interest rate forecasts from global investment banks, the median US policy rate is expected to hold at 5.50% from the fourth quarter of this year through the first quarter of next year, before slightly dropping to 5.25% in the second quarter of next year. This outlook is based on the US third-quarter GDP growth rate (advance estimate, annualized quarter-on-quarter) of 4.9%, which exceeded expectations (4.5%), indicating rising bond yields and increased pressure for Federal Reserve rate hikes, although growth is expected to slow in the fourth quarter.

Germany is also predicted to experience prolonged high interest rates as its government bond yields fall under the influence of the US bond market, with Eurozone inflation exceeding the medium-term target (2%) and slowing down slowly. However, the Eurozone is showing sluggish economic growth, and the effects of monetary tightening are expected to appear with a time lag, necessitating close monitoring of future economic indicators.

In Japan, volatility in global financial markets is expected to increase depending on the progress of monetary policy changes. Last month, the Bank of Japan decided to further ease its Yield Curve Control (YCC) policy at its Monetary Policy Meeting, leading to mixed assessments that this effectively means the abolition of YCC while maintaining a monetary easing stance. As inflation slows more gradually than expected, market expectations for changes in monetary easing policies are rising.

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Strong dollar trend continues... US monetary policy changes as a variable

KIEP analyzed that the strong dollar is likely to persist longer than expected as the Federal Reserve faces a higher possibility of prolonged high interest rates until the 2% inflation medium-term target is achieved. The expansion of the US fiscal deficit is expected to increase the supply of US Treasury bonds, while demand remains limited, exerting upward pressure on Treasury yields. However, if the Federal Reserve halts rate hikes or signals potential rate cuts, there remains uncertainty that the dollar could weaken.

While the strong dollar pressure is intensified by the robust US economy contrasted with slowing recoveries in other major economies, the dollar's strength could reverse once the effects of high interest rates on US demand and economic slowdown begin to manifest.

The yuan-dollar exchange rate is expected to face downward pressure due to global demand recovery, economic improvement, domestic demand recovery, and additional stimulus measures by the Chinese government. However, losses from geopolitical fragmentation between the China-Russia bloc and prolonged risks in China's real estate sector are anticipated to exert upward pressure on the yuan-dollar rate, with the relative importance of these factors determining the outcome. Assuming trade restrictions between economic blocs, commodity-dependent economies like the China-Russia bloc are estimated to suffer greater GDP losses compared to other blocs.

The yen is expected to weaken due to divergent US-Japan monetary policies and significant domestic and foreign interest rate differentials, but the Bank of Japan's policy responses to excessive yen depreciation may limit the extent of yen weakness. The won-dollar exchange rate is expected to remain high due to the strong dollar trend, but if expectations for changes in the Federal Reserve's monetary policy rise, the won-dollar rate could decline. South Korea's large net external financial assets and anticipated expansion of the current account surplus next year act as stabilizing factors for the won-dollar rate, and if market expectations for the Fed's policy shift toward halting rate hikes increase, the possibility of exchange rate decline cannot be ruled out.

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International oil prices, the biggest variable is the Israel-Hamas war

The report forecasts that oil prices will remain high next year due to multiple supply uncertainty factors. In the short term, the direction of the Israel-Hamas war is identified as a key variable. As of the 28th of last month, the death toll on both sides reached approximately 9,400, with Israel occupying the Gaza Strip and the possibility of Iranian involvement raising the risk of a sharp oil price surge. During the Fourth Middle East War in October 1973, Iran, Saudi Arabia, and the United Arab Emirates (UAE) raised oil prices, reduced production, and imposed export bans, causing oil prices to soar from $2.90 per barrel to $11.65 in January 1974, a fourfold increase.

The reduction of US strategic petroleum reserves is also cited as a major factor driving up international oil prices. The Biden administration released large quantities of strategic reserves in response to rising oil prices caused by the Russia-Ukraine war, resulting in reserves falling to 351 million barrels last month, the lowest in 40 years. This level is less than half of the record high in 2010. The report forecasts that it will be difficult to respond with strategic reserve releases if oil prices rise further.

However, factors that could cause oil prices to fall also remain. Last month, ExxonMobil acquired shale gas producer Pioneer for $59.5 billion, and Chevron acquired oil and natural gas producer Hess for $53 billion, indicating that major oil companies are aggressively expanding production capacity.

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Non-ferrous metals and grains expected to stabilize downward due to increased production

Next year, prices of non-ferrous metals and grains are expected to stabilize downward due to increased supply from major producing countries. However, the possibility of upward pressure from future demand increases remains. The report cites the International Copper Study Group (ICSG) forecast, which expects a surplus supply of 467,000 tons of refined copper next year. Copper mining is projected to increase by 3.7% next year, and aluminum supply is also expected to expand as major producers in India and the UAE announce production increase plans.

On the demand side, upward and downward factors are expected to coexist for the time being. The possibility of a prolonged global economic recession due to tight monetary policies is cited as a factor suppressing demand growth, while infrastructure investments by major countries are identified as positive factors for demand improvement.

The International Grains Council (IGC) also forecasts that global grain supply (3.05 billion tons) and production (2.397 billion tons) for 2023-2024 will increase by 2.3% and 2.8%, respectively, compared to 2022-2023. This is attributed to improved climate conditions and expanded crop cultivation areas in major countries such as Russia, Canada, and Australia. However, El Ni?o and the Russia-Ukraine war remain potential risk factors. Some major climate prediction models suggest that El Ni?o will persist until spring next year.

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