Will ballooning inflation and Omicron slow global growth to a trickle?

• After the global economy advanced at its fastest post-recession rate in living memory last year, new fault lines are developing as we head into 2022
• Nevertheless, we still forecast that global growth will remain above-trend this year; however, it’s the outcome of three developing risks – surging inflation, the path of the pandemic, and rising geopolitical tensions – that will dictate the pace of the recovery
• While inflation is currently surging, we expect prices to settle down later in the year – although central banks in many developed economies are expected to raise interest rates along the way
• We also don’t see the world going back to the widespread lockdowns of 2020 as we transition from pandemic to endemic – despite the threat of future spikes

The global economy grew by 6% last year, its fastest post-recession growth rate in nearly eight decades. As we assess the prospects for this year, further expansion seems on the cards.

Policy levels remain supportive, the service sector has further room to recover, and inventories need to be restocked. Furthermore, we anticipate that employment will strengthen and saving rates normalise, which should be positive for domestic consumption, and in turn growth prospects. Consequently, we predict above-trend GDP growth of 4.3% in 2022 (see table).

While we are positive on the outlook for the global economy, there are risks (such as inflation, medical, and political) that may limit the pace of the recovery.

Real gross domestic product growth forecasts, year on year (%)

Note: Weights used for real GDP are based on IMF PPP-based GDP (5-year centred moving averages).

Source: Barclays Research, Barclays Private Bank, January 2022

Inflationary pressures

Upward inflationary pressures have been both much higher and longer than anticipated during the last year. Central bankers have abandoned their “transitory” narrative, as supply-chain bottlenecks took longer to resolve, energy prices surged, and tighter labour markets pushed up wages.

Nevertheless, inflation is likely to decelerate from the second half of the year, as restrictions are removed in many large economies, and capacity increases, leaving aside the risk of a vaccine-resistant variant emerging. Commodity prices are expected to stabilise, and labour supply should also improve and take some of the heat out of wage inflation.

Medical risks

The path of the pandemic is uncertain. The Omicron variant, and resurrection of restrictions, are a reminder that coronavirus spikes will continue as the world slowly transitions from pandemic to endemic.

However, we do not anticipate a return to the previous intense, widespread lockdowns enforced in early 2020. Coronavirus vaccinations have proved successful, and have been adapted to meet new challenges. We should also recognise how much better households and businesses have coped with tighter restrictions, which should reduce the impact of any renewed curbs on physical interaction.

Geopolitical tensions

A range of possible political outcomes exist which could upset the global equilibrium. The world is closely watching the rising tensions between the West and Russia over Ukraine and Nato expansion. This year’s political calendar may impact the direction of policy.

In Europe, the main focus will be on the French presidential election in April, with Emmanuel Macron seeking a second term. In the US, November’s mid-term elections will see all 435 members of the House of Representatives up for re-election. One-third (34) of US senators will also face the electorate, including Democrats in competitive districts in Arizona, Georgia, and Nevada. The outcome of these races may affect the passage of President Biden’s policy agenda.

US inflation to peak in April

The US growth rate has slowed from its post-pandemic peak. Supply-chain disruption, Omicron restrictions, and inflationary pressures have contributed to weaker levels of industrial production and softer consumer sentiment.

We expect supply constraints to ease, and domestic consumption levels to improve, this year. The outlook for the US consumer remains positive, given the huge accumulation of excess savings, strong underlying demand, and healthy labour market (the unemployment rate fell to 3.9% in December, its lowest level since the start of the pandemic¹).

Inflation continues to be a major concern for the US Federal Reserve (Fed). The consumer price index (CPI) surged to 7% in December, the largest annual gain since June 1982². Price pressures are emanating from shelter, used cars, and food. Energy prices, a strong contributor to inflationary pressures over the past year, eased in December for the first time since April, as domestic gasoline prices fell compared to the prior month.

With supply bottlenecks taking longer to resolve, and services inflation set to be anchored by the increase in housing costs, we now expect US CPI to peak at 7.4% in April.

With CPI in excess of 7% and unemployment below 4%, there seem to be few obstacles that will stop the Fed from hiking in March. We can, however, expect the hysteria around inflation to calm through the second half of the year. By the end of the year, we expect US CPI to be around 2.5%. The rapid deceleration should begin to be reflected in rate-hiking expectations, discouraging those economists predicting five or six hikes this year, with three increases being far more likely.

China growth prospects under pressure

Activity in China decelerated to 4% year-on-year (y/y) in the fourth quarter (Q4), ahead of the 3.6% forecast. That said, the growth figure was its weakest since Q2 2020, and down on the 4.9% registered in the previous quarter³.

China’s growth profile has come under pressure from a range of factors, including the slump in the property market, energy shortages, and its commitment to the zero-COVID strategy. In December, property investment dropped 13.9% year on year, and retail sales rose by only 1.7%, compared to 3.9% in the earlier month.

With the two main drivers of growth, property and exports, expected to slow further this year and only a modest recovery in consumption, we look for growth to moderate to 4.7% in 2022, from 8.1% last year.

While other central banks are hiking rates to combat inflation, the People’s Bank of China surprised the markets in January by cutting the cost of medium-term loans for the first time since April 2020. Given the weaker outlook, we anticipate additional easing in the next few months, including a further reduction in the reserve requirement ratio, and another 10-20 basis points (bp) of policy rate cuts in the first-half of the year.

Stalling European recovery pushes back rate-hike expectations

The recovery in Europe is thought to have stalled once again at the end of last year, as Omicron weighed on economic activity. Renewed restrictions sapped consumer confidence, hitting the hospitality and entertainment sectors. Supply-chain disruptions added to the contraction of activity in the important manufacturing sector.

On the positive side, the seasonally-adjusted eurozone unemployment rate fell to a record low of 7% in January⁴, substantially below the 8.2% jobless figure registered in December 2020. Europe, specifically Spain and Italy, should benefit from disbursements from the €750 billion recovery fund⁵. While we have downgraded our Q1 growth forecast, the scaling back of restrictions and easing of supply-side bottlenecks should allow the recovery to resume.

As with other regions, we have increased our projection for eurozone inflation this year, given the surge in energy prices and increase in food inflation. We now expect the harmonised index of consumer prices to average 3.7% in 2022, before slipping to 1.5% in 2023. Despite the relatively hawkish tone emerging from the February Governing Council meeting, we still do not expect the European Central Bank (ECB) to raise rates this year. However, the expected increase in 2023-2024 inflation forecasts, which are due to be published at the March meeting, suggests that rate-hiking expectations may be brought forward from previous projections. We now expect a 25bp increase at both the March 2023 and September 2023 meetings.

UK inflation to ease, with two rate hikes by June

In November, the UK economy finally surpassed its pre-pandemic level, as output recovered more quickly than anticipated⁶. The UK labour market is strong, unemployment having fallen to 4.1%, and job vacancies reaching a record high of 1.25 million⁷. In addition, the service sector has bounced; consumers have been spending, and construction and manufacturing activity have smashed growth forecasts.

We expect data for December and January to show some weakness, given the imposition of restrictions for the Omicron variant, after which the recovery should resume. Our projection is for the UK economy to grow at 4% this year. However, looking into 2023, the combination of Brexit, tax hikes, and higher interest rates suggest that the UK’s growth profile may come under pressure again.

Higher fuel prices, rising goods costs, and escalating food expenditure are driving up UK inflation. CPI is now expected to peak above 7% in April (as Ofgem ups price caps), before decelerating into year end, although still printing above 3% in December. Elevated inflation and labour market tightness encouraged the Bank of England to hike rates by 15bp in December 2021 and 25bp in February. We expect two further 25bp hikes by the middle of this year, putting the base rate at 1% in May, after which we expect a policy pause.