IMF Expects Lower Interest Rates Unless Middle East Conflict Escalates: 'There Will Be Higher Inflation, Lower Output'

The U.S. economy is projected to outshine its advanced counterparts in the coming years with a notable upward revision in its growth forecasts, according to the April 2024 World Economic Outlook.

The forecast predicts a 2.7% growth for the U.S. in 2024 — an improvement by 0.6 percentage points from January’s projections.

For 2025, growth is expected at 1.9%, marking a 0.2 percentage point increase from earlier estimates. This expansion is partially driven by decreasing inflation rates and consequent reductions in interest rates by the Federal Reserve.

Labor Markets and Inflation: The Washington-based institution highlights the resilience of the U.S. labor market and favorable macroeconomic conditions as key drivers of this economic uptick.

These conditions, bolstered by past fiscal stimuli and strong private consumption, continue to exert upward pressure on underlying inflation despite overall improvements.

Globally, the economy is anticipated to maintain a steady growth rate of 3.2% from 2024 to 2025 (similar to 2023’s figures). Both headline and core inflation are expected to decline steadily.

“As inflation converges toward target levels and central banks pivot toward policy easing,” the IMF notes a forecasted dip in the Federal Reserve's policy rate from the current 5.4% to 4.6%.

Impact of Artificial Intelligence, Office Real Estate Crisis: Advanced economies are poised to benefit from artificial intelligence (AI) advancements.

AI could impact approximately 60% of the workforce, with half potentially seeing increased productivity and wages, and the other half facing reduced labor demand and earnings.

On the real estate front, the commercial/office market “is under especially strong pressure” in some economies, with the shift to remote work and higher borrowing costs leading to increased defaults and decreased investments.

Middle East Crisis: The ongoing conflict between Gaza and Israel poses a significant risk of escalating further, potentially affecting the broader Middle East region.

Such a scenario could trigger a moderate 15% hike in oil prices and a dramatic 150% rise in shipping costs, predominantly impacting Asia-to-Europe routes.

This would lead to a global inflation increase of nearly 70 basis points in 2024 and maintain a 25 basis point rise into 2025.

As inflation rises, major central bank would resort to tightening policies again.

“Monetary policy tightens relative to baseline, with rates in both advanced economies and emerging markets about 30 to 40 basis points higher in 2025,” the IMF wrote.

Consequently, global economic activity could diminish by up to 0.4% by 2025, with advanced economies, particularly Europe, feeling a larger impact due to higher shipping costs.

While current global growth projections are optimistic, the IMF remains vigilant about the potential adverse scenarios stemming from an escalation in the Middle East. "There will be higher inflation, lower output," stated Pierre-Olivier Gourinchas, IMF Chief Economist, during a press conference.

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