2023 will be the year when…
… inflation and interest rates dominate
Two very different economic drumbeats may sound in 2023. The further east you go, the stronger the growth forecasts. Meanwhile, to the west, the number one economic headwind is likely to come from a surge in inflation and the bid to control it by raising interest rates.
… efforts to lower inflation bring political instability
Attempts to lower inflation by raising interest rates can be destabilising, especially for highly levered economies like France. Its large numbers of public sector workers, on fixed incomes, are wholly dependent on the state. Rising prices, as a percentage of salary, can impact them disproportionately. In the UK, we’ve seen tensions spill over into industrial action. The Royal College of Nursing, for instance, went on strike over pay for the first time in its 106 year history.
Europe is not the only casualty. Efforts to lower US inflation could unleash a destabilising ripple through 2023, ahead of the 2024 presidential election. And the Asia Pacific region, though less impacted by the energy related repercussions of the war in Ukraine, is more likely to feel the consequences of adjustments in China’s credit market and the continuing economic and political fallout from COVID-19.
If prolonged, unrest can deliver internal political shocks that stoke volatility, leading to severe corrections in the financial markets and reduced investment attractiveness.
… corporate stress and insolvencies increase
Consumers feel the pinch from higher interest rates simultaneously. They spend less, and so there’s less demand in the economy. That, in turn, puts pressure on corporates with weak and over-leveraged balance sheets, and on small retailers dependent on customers’ shrinking disposable income.
Stress is further heightened by the removal of COVID-19 recovery packages that had kept economies afloat. The simultaneity of these pressures makes a rise in corporate insolvencies very likely in 2023. On the UK high street, Made.com and Joules are among the most recent casualties, while some production facilities, like Honda’s plant in Swindon, are closing their doors.
Any glimmer of hope comes, perhaps, from the availability of online training and reskilling courses, which can help people get back into productive activity.
… asset allocations shift
As interest rates normalise – whatever 'normal' means given 14 years’ hovering close to zero – competition for alternative forms of investment could increase. The shift from equities into bonds and credit, with the potential for relatively high returns, will likely continue in 2023.
Moreover, the UK government’s planned relaxation of Solvency II rules, could free up billions of pounds for investment by pension funds and insurers into long-term and less liquid UK infrastructure and green energy projects. This, in turn, will create new opportunity for private equity (PE) investment. But it could, ultimately, kickstart a secondary investment market, as pension funds and insurers step in to buy invested assets once the PE house exits. That long-term commitment could be very good news indeed for PE invested businesses.
But, with interest rates rising, prudency is needed to dampen concerns about the ongoing adequacy of pension fund and insurers’ capital buffers.
… PE-invested assets get stranded
The rise in interest rates and evaporation of cheap debt, could leave some over-levered corporate assets stranded. Indeed, there’s a risk that some PE houses might walk away from assets if loans cannot be refinanced or if equity turn negative.
… struggle continues for commercial real estate
Commercial real estate, notably office space, was hard hit by the global pandemic and the rise in home and hybrid working. Another rocky ride could be ahead in 2023, due to rising inflation and interest rates. Though good quality office space in London is likely to fill quickly, it might be a different story altogether outside the capital.
James Grand's top tips for weathering economic headwinds in 2023
- Economic downturns create opportunity for litigation and class actions. Banks and financial institutions make likely targets due to their deep pockets. Make sure you have contingencies to deal with this type of activity if legal budgets are cut.
- Keep your hands and reputations clean. Address requirements, such as scrutinising the human rights records of your suppliers. Don't do it just because you have to, but because it evidences your commitment to be a good corporate citizen.
- For the vigilant with cash reserves, there is opportunity. Take, for example, the divestment conditions of the European Commission's approval of Germany's €32bn state-funded bailout of Uniper SE. It will offer a once-in-a-generation opportunity to acquire top-quality industrial assets in Europe's strongest economy.
… in conclusion
2023 will be a year of economic downturn, where inflation and interest rates dominate, affecting every aspect of our life, from rising prices to corporate stresses. How governments and corporations tackle these is still to be seen. Check in to read our updates throughout the year and to discover how they are tackled and whether our predictions match up to reality.
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