The global economy appears set to grow at above-trend rates this year and next despite accelerating COVID-19 infection levels, a surge in inflation and the effects of climate change. With a return to wide-spread lockdowns seeming unlikely and with disruptions to supply chains and labour markets set to ease the recovery looks assured.
Predictions that the global economy would enjoy an unencumbered path to freedom always seemed overly optimistic. Over the past few weeks our expectations of a turbulent and uneven recovery have come to fruition as the Delta variant, surging inflation and consequences of extreme weather events took their toll on activity.
However, we remain positive around the outlook for the global economy and expect governments and central banks to make only tentative steps towards policy normalisation in the coming months.
Delta variant hits Chinese economic activity
The Delta variant of coronavirus was formally labelled as a strain of concern in May. It has since been detected in more than 100 countries, becoming the dominant strain of new cases worldwide. The variant is more transmissible than previous strains and has proved better equipped at overcoming both vaccinated and acquired immunity.
China’s zero-tolerance approach has encouraged authorities to impose stringent restrictions to combat the Delta threat, despite a relatively low number of COVID-19 cases and improving vaccination rates.
Many cities have suspended entry to travellers from medium-to-high risks areas, officials have partially closed the Ningbo-Zhoushan port (the world’s third-busiest container port) and shut highways in high-risk regions (such as Jiangsu and Henan provinces). The measures are impacting supply chains (China’s container shipping costs hit new records in August) and consumer confidence.
China’s July activity data reflected this loss of momentum with retail sales, industrial production and fixed asset investment all falling short of expectations. To reflect the shock from the Delta outbreak, we lowered our gross domestic product growth forecasts by 100 basis points (bp) for the third quarter to 4.6% year on year (y/y), and to 8.2% y/y (or 30bp) for 2021.
But it seems different this time
Despite the Delta wave clearly creating additional medical risk, there are significant differences from previous surges. While existing vaccinations may be less effective against contracting the virus, there appears to be a break in the chain between case rates and severe illness.
Hospitalisations and death rates have risen more slowly compared with previous surges in viral infections. This suggests the aggressive restrictions imposed in China, Australia and New Zealand will not automatically be replicated elsewhere, beyond those that are pursuing a zero-COVID-19 strategy.
Inflation elevated, for now
Inflation readings have surged over the summer months to multi-decade highs (from the low base levels of last summer). This creates additional uncertainty for businesses and consumers and ramps up pressure on policymakers to tighten policy. Supply bottlenecks, ultra-accommodative monetary policy, additional stimulus packages and booming commodity prices have all added to short-term price pressures.
Elevated inflationary prints have been encouraging more investors to question whether the central bankers’ definition of transitory was still credible. In the UK, the Bank of England now projects that the consumer price index (CPI) will peak at 4% by the end of this year. In the US we forecast that CPI will approach 6% in November.
However, there are plenty of reasons to believe that price pressures will ease going into 2022 with commodity prices expected to stabilise, supply shortages ease and global demand to rebalance into services from goods.
Wage inflation is one area that policymakers will be evaluating carefully as economies further reopen and job-protection schemes are unwound. Labour shortages due to factors such as fears over the virus, childcare issues and forced self-isolation have each put upward pressure on wages. Expectations are that these pressures should also dissipate, as inactive younger and older workers return to the workforce. The speed of the “back to work” rate will play a crucial role in the pace of wage inflation in the coming months.
Central banks to stay accommodative
Despite the current eye-catching headline inflation figures, we anticipate that central banks will remain accommodative over the next 18 months as inflation starts to fall back towards target levels next year. The US Federal Reserve, European Central Bank and Bank of England look set to keep interest rates on hold through next year.
Quantitative tightening (QT) is likely as central banks start to taper their asset purchase schemes. Reducing asset purchases is likely to be implemented in a controlled and transparent way to avoid disrupting the recovery and unnerving financial markets.
We predict that the Federal Open Markets Committee will either formally announce, or firmly signal, tapering at the September rate-setting meeting. The formal reduction of the rate of purchases would then commence in November, with proportional paring of Treasuries ($10 billion) and mortgage-backed securities ($5 billion) per meeting. This would be consistent with concluding the asset-purchase programme in September of next year.
Climate change remains a risk
The floods in Europe and China, record temperatures in North America and extensive wildfires in the US and Greece are among the latest examples of how climate change is impacting the natural environment. It also creates risks for economic growth prospects.
These recent events are a stark reminder that all companies are vulnerable to the physical, legal and reputation risks that accompany climate change. Investors are increasingly screening companies’ environmental, social and governance (ESG) credentials as part of the investment process.
Incorporating ESG in the investment process is expected to gain further momentum with the twenty-sixth United Nations Conference of Parties (COP 26) scheduled for November. Governments will report on the Paris Agreement’s efforts and set new targets in an attempt to reduce the impact of climate change. These new goals could dramatically affect the operating environment for many companies and lead to further inflows into ESG- focused strategies.
Global growth outlook remains positive
Notwithstanding the disruptive summer, the outlook for growth remains positive as global vaccination rates rise, economic conditions normalise and policymakers remain accommodative. We expect the global economy to grow by 6.2% this year and by 4.7% next year.