"The worsening in the growth prospects for Europe will affect the United States"

Martín Castellano is an Argentine economist. He currently works as Head for Latin America of the influential Institute of International Finance (IIF), the association that represents the world's leading banks and investment funds.

In an exclusive dialogue with LPO, the former official of the Central Bank of Argentina, says that the recession in Europe will hit the United States and that the same drop in the economy will help stabilize interest rates and inflation.

Powell confirmó que irá a fondo contra la inflación y pronostica "dolor" para los hogares por la suba de tasas

"The impact via the credit channel in a context of weak economic growth is going to play an important role in helping to moderate inflation," he said.

The global scenario where most economist foresee a recession does not help to maintain this pace of the US economy...

Global economy faces various combos. On the one hand, it continues to deal with the consequences of the health crisis and supply conditions normalizing more slowly than expected. In addition, there is the fiscal and monetary stimulus, the war in Ukraine, and many other factors, which make the recovery very assorted, and at different speeds according to each country. Among developed countries, the United States emerged quickly from the Covid-19 crisis while the rest of the G-10 countries did it more slowly.

The point is how economic activity will evolve. In some segments, the economy continues to overheat and in others the slowdown is marked. The pandemic accelerated many underlying relevant and structural changes, it brought new challenges and behavioral changes that make it difficult to distinguish between transitory and permanent factors.

An eventual weakening in growth will begin to prevail in economic policy decision-making. All this should mitigate inflationary pressures and give the Fed some leeway.

The indicators do not mark a clear trend ans some people doubt that there will finally be such a marked slowdown.

A high level of surprise has been observed in the latest data and economic indicators in relation to what is expected by the market consensus, which will surely continue. This occurs in activity, employment and prices. We think that the level of activity in Europe will be more affected, China is also beginning to have serious problems to grow and this is going to slow down the global economy, also affecting the US.

We see a scenario where the worsening of growth prospects for Europe will affect the United States and many emerging countries, including Latin America.

Does the rise in rates and the monetary tightening by the Fed also have an effect?

Of course. The withdrawal of the monetary stimulus will have an impact on economic activity. However, we see a change in the Fed's position that opens a possibility of a more gradual scenario in raising rates. Basically, there are four elements that could support a more gradual adjustment: some moderation in inflation, more restrictive financial conditions, mainly in the real estate market, anchored loterm inflation expectations, and the growing risk of a global recession. All this means more space to limit the withdrawal of stimulus.

We think that the level of activity in Europe will be more affected, China is also beginning to have serious problems to grow and this is going to slow down the global economy, also affecting the US.

Is inflation already giving signs that the rate hike was effective?

The rate increases expected for this year are in line with market expectations. In this sense, the impact via the credit channel in a context of weak economic growth will play an important role in helping moderate inflation. An advantage in the disinflation process in the US is that, unlike Latin American countries, elements such as "inflationary history" or indexation that can make inflation more entrenched and persistent, do not weight as much.

Did the market exaggerate the reading of Powell's sayings that there will be "pain" for the economy in order to lower inflation?

What the Fed says in its latest communications is simply that its options are going to continue open. No more, no less. The message is that they will continue to be "data dependent" and that they will proceed with caution. We see that financial conditions have already tightened quite a bit in the US. In a growing risk context of a recessionary world, of normalization in some of the supply conditions and of medium-term inflation expectations under control, an eventual weakening in growth will begin to prevail in decision-making economic policy. All this should mitigate inflationary pressures and give the Fed some leeway to slow down with rate hikes.