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Normalisation, but not as we know it

The pandemic, inflation and labour markets pose challenges for central banks

The pandemic, inflation and labour markets pose challenges for central banks.

First, the good news. The global economy is heading into 2022 in a better place than we might have expected a year ago. COVID-19 vaccines have been rolled out in large parts of the world, there has been a robust economic recovery, and medium-term scarring is much less apparent than anticipated.

However, things are still far from normal. The battle against the virus continues, with Europe re-imposing restrictions to slow the spread of the highly transmissible Omicron variant. Supply chain bottlenecks, higher energy and food prices, surging consumer demand and higher wages have sent inflation in the US and Europe to multi-decade highs. The hopes of this time last year that inflation would be ‘transitory’ have faded.

Labour markets have also changed since the pandemic. The US, the UK and many advanced economies face worker shortages. Will more workers return to the labour market, helping to ease bottlenecks and temper wage growth – and, if so, how quickly? The answer will have a major influence on productivity, inflation, interest rates and the trajectory of the dollar over the coming months.

Developed market central banks, then, find themselves grappling with competing challenges. Inflation is clearly their chief concern at present. The December meeting showed that the Federal Reserve is keen to avoid the mistakes of the 1960s and 1970s, when the chair let inflation run too hot for too long. It is stepping up its tapering, and projections point to three rate rises in 2022. The Bank of England has now started to raise rates. The European Central Bank plans to end its emergency bond purchases in March and scale back the regular asset purchases thereafter.

So these central banks are seeking to get back to ‘normal’ monetary policy. But nothing can be taken for granted given the continuing pandemic uncertainties, as shown by the last minute changes to anticipated policy rate decisions by the Reserve Bank of New Zealand and the Bank of England in recent months.

Whatever the Federal Reserve and other major central banks do will have big implications for the emerging economies, which already face a tough backdrop from the pandemic, a stronger dollar, and a slowing mainland China. Many emerging economies are, at least, better prepared for gradual interest rate rises in 2022-2023 than they have been in the past. And Asia, in particular, is better placed than other emerging regions, given a solid growth and investment outlook, and room for catch-up on the consumer side. Nonetheless, emerging market assets had a poor year in 2021: the question is whether conditions in 2022 will be any better for them.

Given the many moving parts in play, there is huge uncertainty about the outlook for next year and beyond. We anticipate some easing of bottlenecks, and an increase in labour participation – but this could take a while, and with uneven progress across different economies. Our forecast for global GDP growth in 2022 is unchanged at 4.1%. Downgrades to the eurozone, Russia, Brazil and others are offset by upgrades to many economies in Asia-Pacific, notably India. We edge up our global GDP growth forecast for 2023 to 3.2% from 3.0% thanks to marginal upgrades to the US and the eurozone.

The biggest changes are to our inflation forecasts. We now anticipate global inflation of 4.6% in 2022 with hikes to our projections in virtually every economy. Overall, our forecasts for the next couple of years, and certainly for 2022, suggest a deteriorating trade-off between growth and inflation.


First published 17th December 2021.

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