The global economy will experience several years of above-trend growth as it rebounds from the Covid crisis, helped by vaccine rollouts, accommodative fiscal and monetary policies, and as firms and households adapt better to restrictions where they remain.
The near-term strength of demand, amid supply bottlenecks, is generating a period of higher inflation. Although we expect this aggregate inflationary effect to be largely temporary, there will be meaningful divergence across countries and sectors. Moreover, medium-term inflation risks are skewed to the upside.
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Vaccine rollouts supporting global growth
Vaccine rollouts are proceeding at pace in the US and UK, and have ramped up meaningfully for earlier laggards such as Europe and China. This is allowing the progressive dismantling of remaining lockdown restrictions and a strong rebound in economic activity. Although a pickup was factored into our previous forecasts, it has been somewhat faster than expected. That’s why we have revised up our growth forecasts in most of these rapid-vaccination economies.
However, while some economies move ‘post pandemic’, fresh waves of Covid are weighing on the likes of India, Japan, and much of South America. Africa remains at risk given the low level of vaccine penetration on the continent. We expect a renewed economic contraction in India, and we have lowered our forecasts for Japanese growth. Meanwhile, there are signs of greater vaccine hesitancy in some economies in the Asia Pacific.
Our aggregate global economic forecasts are strong: growth of 5.7% in 2021, 4.8% in 2022 and 3.4% in 2023 – well above trend. But divergences between early and late vaccinators, between developed and emerging economies, and between the manufacturing and services sectors, are key themes.
Headline inflation peaking, upside risks prevail
Headline rates are being pushed higher by strong energy prices, expiring tax cuts, and a re-weighting of inflation baskets to reflect lockdown consumption patterns. Base effects are inherently temporary, and should peak within a matter of months.
However, other drivers of the recent increase in inflation may prove more persistent. Bottlenecks, as rapidly rebounding demand comes up against supply constraints, are putting upwards pressure on producer and core goods consumer prices. This trend will likely broaden into service-sector prices later in the year. Nevertheless, in our base case, these effects will ultimately prove temporary as some of the heat comes out of demand, and supply constraints ease.
We don’t think the conditions for a more sustained global inflation regime shift – prolonged above-target inflation expectations, considerable spare capacity and central bank tolerance for persistently above-target inflation – are in place.
Fiscal austerity avoided
Fiscal policy remains an important tailwind for some economies. In the US, President Joe Biden’s two-part infrastructure plan is meant to be fully tax funded, will be amended as it passes through Congress, and spending will be spread over at least eight years. But the package should still represent a large and sustained source of net support for the economy.
European economies are close to unlocking NextGeneration EU funding, which will pick up some slack as domestic spending moderates, although the boost will be less than in the US. But in a number of emerging markets, we are concerned that a combination of higher bond yields and a fear of ratings downgrades will lead to economically damaging austerity budgets.
Tight global monetary policy some way off
While overall monetary policy remains loose, at the margin, central banks will start to reduce the extent of accommodation over the next few years. The Federal Reserve has started to ‘talk about talking about’ tapering stimulus measures, and we think it will reduce asset purchases from early 2022 and hike rates in the second half of 2023 (although there is some risk it does so earlier).
Meanwhile, the Bank of England (and soon the European Central Bank) is reducing the run rate of asset purchases (without changing the cumulative amount of purchases), even if actual tapering and rate rises remain a long way off. Elsewhere, Chinese financial conditions have moved back to neutral territory but are not unduly restrictive.
A divergent global recovery is contributing to a withdrawal of accommodative policies in many emerging markets. The rise in US Treasury yields, along with higher inflation, has forced some central banks to draw easing cycles to an end (e.g. Mexico, South Africa), and others to raise interest rates (e.g. Brazil, Russia, Ukraine).
Fewer headline political risks, fragmentation continues
The foreign policy shift under the Biden administration has shored up traditional US alliances but it has also amplified rivalries. The geostrategic conflict between the US and China, in particular, will continue to create rifts in the global economy.
In Europe, the outcome of German federal elections later this year could mark a profound economic and policy shift given that the German Greens should form part of the governing coalition. In the UK, a pro-independence majority in devolved Scottish elections means another independence referendum is back on the radar.
Don’t forget the tails
We find focusing on ranges and scenarios more useful than point forecasts. Downside scenarios – involving vaccine escape or the premature withdrawal of policy support – would weigh on growth and inflation. But the overall balance of risks around our forecasts is to the upside.
Inflation could be higher (but growth lower) than we are expecting if supply chain disruptions prove longer lived, and pass into wages and prices. Growth could be higher (but inflation lower) if scarring from the crisis is avoided.
Finally, a rapid rundown of savings built up during the pandemic would boost both growth and inflation above our baseline expectations.