Anemic Growth, Stagflation Risks and a $2T Hole for the Construction Sector

The latest IMF World Economic Outlook paints a bleak picture of the global economy, with anemic growth, stagflation risks, and a $2T hole in the construction sector. However, the IMF analysis suggests that the current surge in inflation is a blip and not a global reset. Inflation is almost entirely linked to the pandemic and the distortions in supply and demand it created. While recovery into growth is not assured, poor productivity and unhelpful demographics in major Western economies will drag down inflation and take interest rates back down to pre-pandemic “natural” levels.

However, the bigger risk is not high inflation and interest rates, but low growth. If major developed economies struggle to turn low-inflation stability into low-inflation growth, policymakers will probably feel forced to intervene. More quantitative easing or other balance sheet adjustments might be the policy option chosen by central bankers. Given that central banks only just began quantitative tightening, this would be serious, and it may have unpredictable consequences.

The real estate sector faces a more perilous route than policymakers in government and central banks. Oxford Economics warns that persistent high prices could blow a $2T hole in the global construction business. While core inflation is expected to come down steadily, thanks to easing supply chain pressures, and interest rates just high enough to choke off the pressure, there are risks that high inflation could be stickier than expected. The construction sector is particularly vulnerable, with construction material prices expected to be at least 15% higher than pre-pandemic levels when prices bottom out. If a wage-price spiral gets going, the sector will tumble into a $2T hole of foregone construction activity in the years to 2027.

Overall, the IMF analysis suggests that recent increases in real interest rates are likely to be temporary. When inflation is brought back under control, advanced economies’ central banks are likely to ease monetary policy and bring real interest rates back towards pre-pandemic levels. How close to those levels will depend on whether alternative scenarios involving persistently higher government debt and deficits, or financial fragmentation materialize.