Can the global economy sustain its strong rebound?

• We’re forecasting impressive global economic growth at 6.3% in 2021, underpinned by reopening economies as COVID-19 restrictions ease
• The recovery is expected to be driven by consumer spending, fuelled by excess savings and pent-up demand
• Recent increases in inflation expected to be short-lived, with slack in the labour market likely to limit pressure for rate hikes
• Governments to retain aggressive fiscal policy for some time – largely through increased spending – to limit economic scarring from the pandemic.

The economy has had a strong start to the year. Its momentum is likely to persist into next year, driven by consumer expenditure and supported by a government spending splurge and accommodative monetary policy.

The outlook for the speed and magnitude of the economic recovery seems far better now than it looked at the start of the year as activity rose from the coronavirus ashes of 2020. As expected, the shape of the recovery has been simultaneously robust, turbulent and uneven.

Our enhanced growth trajectory forecast is driven by a range of factors including the improving health situation, relaxation of restrictions, ongoing aggressive policy support and the strength of the consumer. We expect growth to be an impressive 6.3% this year now, having forecast it would be around 4.8% in January. The strong momentum is likely to continue through 2022 with growth of 4.6% that year (see table).

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

Vaccine programmes underpin growth prospects

As we referenced in our Outlook 2021, growth prospects will undoubtedly be determined by the lifespan, intensity and geographical spread of the virus. The vaccine outlook has improved over the past six months and there seems likely to be a material improvement in preventing the spread of the virus in the coming months.

There are now seven coronavirus vaccines approved for use in at least one country. The number of global vaccinations has surpassed the total number of confirmed cases. Nearly 2.5bn doses have been administered, with Israel, UAE, US and the UK among countries with some of the highest percentage of their population vaccinated.

The UK and US is expected to achieve herd immunity (thought to be around 70% of the population vaccinated) in the third quarter with Europe inching towards that status by year end.

Ongoing vaccine challenges

Notwithstanding the medical progress, it is important to recognise that there are still a number of vaccine unknowns, including the length of immunity, efficacy against future mutations as well as possible side effects.

The path to the normalisation of activity could be impeded by vaccine hesitancy and difficulties around global distribution. A pandemic requires a global solution and vaccination data continues to show that inoculation rates in many countries remain low.

The fiscal flood continues

Despite last year’s record rise in peacetime government borrowing, policymakers seem ready to pull even harder on the fiscal lever in the second half of this year.

Most notably, Joe Biden’s administration in the US has argued for $4tn in new federal spending and tax credits over eight years. The Organisation for Economic Co-operation and Development (OECD) estimates that the stimulus plan will add one percentage point to global growth. A significant amount.

While a number of long-term investment packages continue to be negotiated, some of the emergency fiscal measures, such as furlough programmes, are likely to taper off this year.

Uneven labour market recovery

Following the withdrawal of job retention schemes, the return to work rate will be of particular interest to economists.

The labour market recovery is expected to be uneven across regions. US unemployment has fallen dramatically over the past few months, despite some recent loss of momentum. Similarly, in the UK the extension of the furlough programme and faster reopening of the economy have reduced our forecast of peak unemployment. Conversely, we anticipate that eurozone unemployment will be elevated for some time.

Power of the consumer

The reopening of service sectors, high saving rates and the unleashing of pent-up demand is expected to generate a powerful consumer-led recovery over the next year.

The mixture of forced savings, higher precautionary savings, rebate cheques and ultra-low interest rates provide consumers with considerable financial firepower. If even only a small percentage of the accumulated wealth is spent over the next year, it would lift growth prospects significantly.

The threat of inflation

Inflation forecasts have been rising this year as low base levels from last year. Supply bottlenecks, ultra-accommodative monetary policy, additional stimulus packages and surging commodity prices all add to short-term price pressures.

Given the broad range of both demand-pull and cost-push inflationary pressures, it’s perhaps no surprise that year-on-year inflation data look set to significantly rise over the course of this year. For the UK, Europe and US, headline inflation is projected to be more than one percentage point higher than in 2020.

However, many factors suggest that the inflationary pressure is transitory in nature. The level of spare capacity in many economies remains high compared to before the pandemic which should help anchor inflationary pressures. Wage growth, often associated with accelerating core inflation, is not materialising due to the amount of slack in the labour market. Rapid digitisation and investment in technology are also likely to keep wage growth muted, even when labour markets recover.

Is tighter monetary policy on the horizon?

The impact of stronger inflation on monetary policy may be more benign than recent hikes in bond yields suggest, considering that medium-term inflation forecasts remain below central banks’ mandated target levels.

As such, the US Federal Reserve, European Central Bank and Bank of England will probably keep rates at historically low levels this year and next. Nonetheless, with price pressures becoming more ingrained than forecast, there is clearly pressure on central banks to begin to consider tapering asset-purchase programmes in the coming months.

Fiscal consolidation to be postponed

The fiscal policy response, and its timing, have been key to the economic recovery. Without the aggressive and innovative solutions taken by many governments, the economic scarring from the pandemic would have been worse.

How readily businesses and consumers adapt to the withdrawal of emergency support measures will play a key role in determining the rate of recovery. Eventually, public finances will need to be put back to a sustainable path.

Higher taxes and substantial cuts in government spending seem inevitable, although this process is unlikely to start until the recovery is assured.