Economic environment overview: World economy 2023-2024

Year 2023 was a very challenging period for the global economy. The war in Ukraine lasted longer than expected, and a new factor was added to geopolitics - the Israel-Hamas conflict, which, in addition to diverting attention from the Ukrainian war, has at times also divided Ukraine's allies. The war in Ukraine, climate change, and India's restrictions on rice exports caused a global rise in food prices.

The arrival of ChatGPT and other similar creative artificial intelligence programs to mass consumers could significantly impact the job market. While it has been previously thought that automation only affects the disappearance of jobs with routine tasks requiring moderate qualifications, new programs are being used in creative positions as well, reducing the need for human labor. However, global labor markets have been able to withstand the economic slowdown well - unemployment has remained relatively low, and we have even seen wage growth.

The three main factors influencing the economic development in 2023 were:

• Energy supply security - while it was still unclear at the beginning of last year how successful it would be to replace Russian gas with new suppliers and alternative energy sources under sanctions, today we can say that a relatively mild winter and new supply channels have solved this problem quite successfully. However, energy prices have remained significantly higher than before the war and have thus been an important factor in inflation.
• High interest rates - while slowing down economic recovery, high interest rates have reduced the production of durable goods financed by credit and affected the real estate market along with residential construction. Although inflation has slowed down globally, most forecasts do not see it reaching the desired 2% in 2024.
• High energy prices - in the global perspective, countries exporting energy carriers (mainly gas and oil) have won and those with a large industrial sector have lost. They were more affected by the price increase because industry is generally more energy-intensive than the service sector (e.g., the German economy turned into decline in 2023).

What can we expect from 2024?

The world economy will gradually emerge from the crisis in 2024, but the recovery will be slower than originally expected. India and China's economies are likely to fare the best, followed by the USA. The situation in the European Union's economy is the most uncertain. Already in January, it was evident that central banks had lowered their economic growth forecasts - the German central bank forecasted 0.4% growth by the end of the year, the French central bank 0.9%, and the Italian central bank 0.6%.

The beginning of 2024 brings a dilemma for Europe - whether to lower interest rates already at the beginning of the year or in the second half of the year? The main argument of the European Central Bank against lowering interest rates at the beginning of the year is the relatively high inflation rate. However, if the economic growth indicators for the fourth quarter of 2023, to be published in March-April, are worse than expected, inflation is expected to slow down. Another argument for lowering interest rates is the high debt burden of countries. Servicing existing loans has already become a noticeable burden on the budgets of countries, and servicing new loans needed to stimulate the economy is expensive. According to current forecasts, inflation indicators in the eurozone will not reach the target level in 2024, and therefore there is no reason for the European Central Bank to quickly lower base interest rates.

The change in interest rates directly affects exchange rates

If the forecast materialises that the US Federal Reserve will start lowering interest rates already at the beginning of 2024, but the European Central Bank will do so only at the end of 2024 or at the beginning of 2025, then, based on simple economic logic, it can be assumed that the euro will appreciate against the US dollar. The appreciation of the euro, in turn, will negatively affect the economic indicators of major exporters in the European Union (especially Germany). Problems in the German economy will, in turn, affect the Scandinavian countries, and this will reach the Baltic countries as a domino effect.

In conclusion, geopolitical uncertainty continues, and inflation pressure tends to negatively affect investment activity. When combined with the growth of protectionism and the reduction in export volumes, it is difficult to find a significant growth engine in the global economy in 2024. At least in Europe, we see rather zero growth or stagnation in the economy.

Raul Eamets
Chief Economist of Bigbank Group