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Speed bumps on the road to recovery
07 Apr 2021
World economic growth prospects remain strong this year as governments unveil fiscal support packages, pandemic restrictions ease and vaccination programmes gather speed. Still, there is a risk that the recovery diverges as some countries see a resurgence of the coronavirus. We have trimmed our growth forecasts for the world and Europe in our latest Global Economics Overview, but see a more robust performance in the US and the UK.
Some countries are immunising their populations rapidly against Covid, but the pandemic is sweeping through others again, especially in India, Brazil and parts of the European Union. But the broad direction of travel is still one of optimism regarding world growth in 2021, as markets eye a gradual loosening of restrictions. We concur, but we have pulled our 2021 global gross domestic product (GDP) forecast down by 0.3 percentage points to 6.2%, principally as China uses space to deleverage its financial sector. But China can already achieve its target of more than 6% GDP growth in 2021, even if its economy treads water for the rest of the year. We now estimate China's economy will expand about 9% this year (compared with our previous forecast of 9.8%). Against rising short-term interest rate and inflation expectations, government bond yields have risen sharply. For example, 10-year Treasury yields are up by 74 basis points on the year so far. However, note that market predictions have tended to overestimate the level of yields since the financial crisis, which has nudged us to make relatively modest changes to our forecasts.
March saw US President Joe Biden sign his $1.9 trillion American Rescue Plan into law, adding to Donald Trump’s $900 billion Covid Relief package. Taken together, this represents an unprecedented fiscal boost worth 13% of GDP. But more stimulus is on the horizon, with the White House considering a multi-trillion dollar infrastructure plan. As such, we forecast growth of 5.9% in 2021, but a figure over 6% is entirely possible. Meanwhile, we have revised our 2022 forecast upwards to 4.8%. For markets, the critical question is what the upgraded outlook means for Federal Reserve policy, with an interest-rate increase in the first quarter of 2023 now fully priced into the curve. Given the Fed’s desire to make up for periods of low inflation, we suspect that the first hike in the Fed funds target rate range will come later in the fourth quarter of 2023. Ahead of a move in rates, we expect the Fed to announce a tapering of asset purchases at the end of this year.
Attention remains firmly focused on the race between the spread of the newer and more contagious strains of Covid-19 on one side and vaccinations on the other. So far, the pace of inoculations has been too slow to contain, let alone diminish the disease’s incidence. As a result, social restrictions have had to be extended in several countries. This will hold back the economic recovery in the second quarter and explains the European Central Bank’s insistence on countering any tightening in financial conditions for the time being, including its decision this month to front-load quantitative easing bond purchases. But if vaccinations take the planned step up during the second quarter, then activity should rebound strongly. Still, we have cut our 2021 GDP growth forecast from 4.6% to 4.4%, and our 2022 forecast from 5.2% to 5% as a result.
Domestically, the economic outlook has brightened. Monthly GDP data for January revealed that economic activity was more resilient than expected during the country’s third national lockdown, contracting by 2.9% on the month, relative to a consensus forecast of a 4.9% drop. In light of this, we have upgraded our first-quarter GDP forecast to -1.8%, which lifts our annual 2021 growth forecast by 0.9 percentage points to 7.3%. On monetary policy, we have opted to shift our first Bank of England interest-rate increase forward by a period of six months to mid-2023. This reflects the optimism regarding the economic recovery’s strength and timing, underpinned by the impressive pace of vaccine rollout, enabling a faster move towards normality than once envisioned.
That said, in last month’s Global Economic Overview, we noted that some economies had performed better than expected in the fourth quarter of last year. Economies appear to have gained resilience under lockdown with activity holding up impressively – the UK in January is a good example. Overall, our forecasts of world GDP for 2021 have increased since the back end of last year (Chart 2), reflecting increased optimism, although this is partly due to the magnitude of US fiscal stimulus. However, our growth forecasts are a touch lower this month, mainly because of our view on China. We now look for 6.2% and 5.1% growth this year and next, compared with 6.5% and 5.2% previously.
Since the start of the year, a common global theme in markets has been the rise in inflation expectations. A combination of large fiscal stimulus, ultra-loose monetary policy and renewed economic optimism has led market spectators to debate the potential for an increase in future inflation. We can see this in five-year, five-year inflation swap rates, a market measure of where investors believe five-year inflation will be in five years. In the US, the UK and the euro area, markets have upgraded their medium-term inflation expectations. Since the start of the year, euro-area expectations have risen the fastest of the three, but expectations are still firmly below the ECB’s "below, but close to, 2%" target.
Markets are scrutinising Fed comments for changes in signals over the likely timing of its stimulus measures' winding down. The Federal Open Market Committee (FOMC) maintained the Fed funds target at 0%-0.25% this month. The central bank's median "dot plot" projection indicated that policymakers would keep it there until after the end of 2023. Markets disagree – the curve is fully factoring in a 25-basis point increase in the first quarter of 2023. No one can be confident about timing, including FOMC members. While fiscal policy will likely pump-prime demand, it is not clear how much wage inflation will ensue. For now, unemployment is elevated at 6.2%, and we note that wage growth failed to reach 3% in the post-financial crisis period, even when the jobless rate fell below 4%.
Also, as we pointed out last month, the US's primary inflation measure has been running 0.4 percentage points below the central bank's 2% objective over the past 10 years, giving the FOMC licence to aim for inflation above 2% for a while via its "makeup" strategy. Overall, we are now looking for a Fed hike in the fourth quarter of 2023 (we previously forecast 2025), partly reflecting the view that the FOMC will leave its balance sheet contraction until later. With Fed members reticent to push back against a steeper yield curve, we think 10-year Treasury yields will rise faster than we previously thought – we now see 10-year Treasury yields rising to 1.75% by the end of the year, compared with 1.25% previously. However, higher mortgage rates may dampen housing activity and slow the economy, acting as a brake on curve steepening.
The Fed's $80 billion per month in asset purchases has been a notable presence in the treasury market. However, it is also worth considering net issuance, where supply has outstripped purchases every month other than between March and May 2020. Looking forward, this is set to continue, with the possibility of 2021 net Treasury issuance reaching $2.8 trillion, should issuance in the second half of the year match that in the first half. This figure could rise even further should a proposed multi-trillion dollar infrastructure plan pass Congress by then. That begs the question of whether this might impact market conditions later this year should the Fed taper its purchases. To date, the market has absorbed supply, but one or two weak auctions have raised concerns.
These rising infections and tighter social rules represent a renewed headwind to near-term economic activity. As such, we have downgraded our Eurozone GDP forecasts for 2021 and 2022 to 4.4% and 5%, respectively. However, while we have nudged our outlook for the first half of 2021 down, we see this as a short delay in the recovery and expect progress in vaccinations and an unwinding of social restrictions toward the end of the second quarter to prompt a significant rebound in activity in the third quarter. In terms of economic growth distribution, the four core countries are expected to see faster expansion than the remaining 15 countries, which is unusual. That reflects the differing severity of the downturn in 2020 and hence the likely size of the rebound.
March’s ECB meeting saw the central bank’s Governing Council commit to a significant pickup in the pace of asset purchases over the next quarter in response to rising sovereign yields. Policymakers gave no specific guidance on the exact size of purchases, but the first week’s data has shown an uptick to €21 billion, 50% higher than the average in January and February. We estimate that monthly purchases will lie in the €70 billion-€100 billion range. But this will be flexible and influenced by broader financial conditions. Note that this is in addition to the €20 billion per month purchased under the original Asset Purchase Programme (APP). More broadly, our views around ECB policy envisage the Pandemic Emergency Purchase Programme (PEPP) ending as planned in March 2022 and the APP running to the end of 2022, before the first rise in interest rates in the fourth quarter of 2023.
The UK’s trading relationship with the European Union following the end of the transition period has got off to a shaky start, with January’s imports and exports of goods plummeting by 28.8% and 40.7% on the month, respectively. Although stockpiling ahead of the deadline is a significant contributing factor, our rough estimates suggest that it can only fully explain the decline in imports – exports to the EU would still be some 34% lower even without stockpiling effects. That indicates other factors, such as new regulations, are also limiting trade. Indeed, a survey by the British Chambers of Commerce in February confirmed that 49% of UK-based exporters had reported difficulties in adapting to new protocols since the start of the year.
UK labour force data are derived from a household survey - results are scaled up based on population projections. With unexpected large population swings, this can lead to odd results. Currently, official data show a jump of over 1 million in the UK-born working-age population between the fourth quarter of 2019 and the fourth quarter of 2020. However, suppose one assumes that the number of UK-born people to have been steady. In that case, the data imply tentatively but more plausibly a large net migration out of the UK and a fall in the total working-age population to the tune of 2.8%. It is not clear how many migrants would return in a post-pandemic recovery, particularly from the EU. If so, the pre-pandemic level of GDP may not be a good yardstick to gauge spare capacity.
According to our estimates, in January, UK consumers had amassed £108 billion in excess savings since the start of the pandemic. However, this improvement in personal finances has not been seen universally across society, causing concerns regarding widening inequality. Indeed, lower-income groups, who are more likely to be employed in industries hit hardest by the pandemic, have decreased savings. More surprising is the age breakdown, with younger cohorts, who typically have a more significant marginal propensity to consume, building up a stock of savings. In contrast, the 50-64 age group have reported a net decrease in savings.
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