Global economic recovery continues

Inflation is the new risk and some central banks are proving more patient on policy than others

29 June 2020 Janet Henry, Global Chief Economist

Central banks had a common response a year ago to the pandemic: turn on the liquidity taps. The global economic rebound has been stronger than feared – but inflation has been higher too. Central bankers are now responding in their different ways, with some starting to reduce the stimulus while others wait to see how high inflation goes and for how long.

Some emerging countries are already raising interest rates and tapering asset purchases. But what matters most is what the US Federal Reserve does, and it has just taken a hawkish turn, signalling slower asset purchases and two possible rate rises in 2023.

Its new ‘average inflation targeting’ regime allows it to moderately exceed the 2 per cent goal but the Fed now seems willing to overshoot even further – temporarily. Yet if inflation rises too far, can the Fed generate a soft landing?

Globally, COVID-19 remains the biggest downside risk with restrictions on domestic mobility disrupting activity until vaccines become more widespread. And the biggest upside risk is a rapid drawdown of the huge savings accumulated during the pandemic, fuelling a stronger consumer rebound that feeds inflation.

But there are many other uncertainties posing risks to growth and inflation. How much will fading fiscal stimulus slow activity? How much will global goods demand slow as spending rotates towards services? Will worldwide housing-market booms gently deflate – or prompt more macro-prudential measures? How much will economic reopening slow production and trade in goods as demand for services rebounds? Or will an investment recovery boost capital-goods exports? What of commodity prices?

And will worker shortages – particularly in the lowest-paid sectors – abate once government support schemes end this year, even in countries dependent on immigration? Or will higher wage growth exacerbate inflation?

We still expect a fairly patient US Fed to start tapering its asset purchases in December, but we do not expect interest-rate rises before mid-2023.

Some G10 central banks could move rates higher earlier: Norway this year, New Zealand and Canada next year, while we expect two rate rises totalling 40 basis points from the Bank of England in 2022.

Some countries with higher inflation expectations, like Brazil and Russia, have already raised rates significantly and will hike further, and South Africa, Chile and Norway are expected to have noticeably higher policy rates at end-2022 than today.

Our global growth forecasts have been revised up from 5.6 per cent to 5.9 per cent for 2021 and from 4.1 per cent to 4.2 per cent for 2022 thanks to upgrades for Europe, North America and Australasia. In emerging markets, downgrading India from 11 per cent to 7 per cent this year offsets higher forecasts elsewhere, particularly in Latin America but also the Central Eastern Europe, Middle East and Africa region.

Our 2021 inflation forecasts have moved up in most countries. Aside from Argentina, the biggest upgrade is for the US, where we predict 3.8 per cent, falling to 2.1 per cent next year. But despite having some of the strongest GDP forecasts, the smallest inflation upgrades are in Asia, reflecting the relatively subdued pace of the consumer spending recoveries there.

First published 24th June 2021.

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