The recovery from the coronavirus crisis has been rapid, and the short-term global outlook continues to be robust although possible new virus mutations can weaken the outlook. As a consequence of the rapid recovery, inflation has accelerated worldwide but so far mainly because of higher oil prices and post-pandemic price corrections. We expect inflation rates to decline significantly in 2022, but, for the first time in years, there are upside risks to inflation, and the labour market outlook is particularly interesting in many countries. The Fed is expected to start hiking rates next year, which should benefit the dollar.
In most developed economies with high vaccination rates, the pace of the recovery has been fast, and they are already close to their pre-crisis GDP levels. In these countries, the short-term outlook is also robust as we expect the current wave of the Delta virus to not trigger another round of widespread restrictions. However, emerging economies with lower vaccination rates are much more vulnerable and, overall, new mutations possibly resistant to the existing vaccines continue to be the biggest downside risk to our forecast.
As a result of the exceptionally fast recovery, economies are facing new challenges as the extreme shifts in both aggregate and sectoral demand test the economies’ capability to reallocate resources rapidly. Signs of overheating are appearing in some parts of the global economy as we are quickly returning to high production and capacity utilisation levels. In addition, demand is strong due to low financing costs and the relatively robust situation of households that now hold a vast amount of excess savings. Flexibility is thus needed especially in the labour markets of many countries where the number of job vacancies is record high while unemployment remains elevated. Otherwise, growth will slow suddenly.
At what levels will inflation stabilise?
Labour market developments will also be the key for inflation prospects. In 2021, higher energy prices and post-pandemic price corrections have lifted inflation, but it remains to be seen to what extent this is a temporary phenomenon. Uncertainty about the inflation outlook is higher than for many years. In the US, we see many signs of sustained wage and price pressures, but the key question is whether the people who left the labour market during the pandemic will return. In the Euro area, the existing wage agreements imply that the basis for wage growth in the near term will be low. However, now that inflation rates are high, especially in Germany, it will be interesting to see whether the tone in wage negotiations will change. Also in China, the global bottlenecks are reflected in higher producer prices. However, China’s wider inflationary pressures seem to be under control, and the authorities have a large tool bag to control price developments in the country.
GDP growth forecast, % Y/Y
The pace of the recovery will slow in the US
In the United States, economic activity has rebounded, and GDP is back at its pre-pandemic level. Households quickly responded to the reopening of the economy, and consumer spending has surged back to its pre-crisis trend. However, the impact from the stimulus package in March is fading, and consumer confidence is weakening due to the current Delta Covid wave. On the positive side, there are early signs that supply-side disruptions are easing, especially in the labour market. Fiscal policy is expected to be accommodative going forward, but the outlook is cloudy until at least October.
China’s political priorities have global impacts
The Delta virus has found its way also to China, and China’s growth will be hindered by lockdowns in the coming months. The major downside risk in the short term is that the Chinese vaccines turn out to be inefficient against the new virus mutations and that the lockdowns will be more persistent than in the developed economies. The negative impact of China’s slower growth will of course be felt globally, but at a sectoral level the impact can be even more dramatic. As we have recently seen, Chinese leaders are not afraid of making rapid economic policy shifts, causing volatility in many sectors. The Chinese internet giants, tutorial companies and e-games have been mostly affected. One recent example of a policy shift causing global consequences is the stricter regulation of China’s steel industry. The production cuts have caused the iron ore price to decline but at the same time increased pressures on steel prices.
Euro-area growth is expected to be above the long-term potential in the coming years.
Tuuli Koivu, Nordea Chief Economist
Euro area: country-level differences
Euro-area GDP as a whole is expected to be at the pre-crisis level by the end of 2021. However, country-level developments vary substantially as countries such as Spain that are dependent on foreign tourism are still lagging behind. The implementation of the NGEU recovery fund has proceeded, and the first disbursements have been made. The largest economic impact of the fund is expected to be seen in 2022-2023, thus keeping economic growth above its long-term potential in the coming years and bringing the EU close to its pre-pandemic trend. However, it remains to be seen whether substantial structural reforms are carried out as part of the investment programme and whether the long-term growth prospects – key for the debt sustainability in many countries – will genuinely improve. From a political perspective, the uncertainty is increased by the approaching elections in, for example, Germany and France.
Bond purchases not preventing higher yields
The Fed’s rhetoric has changed, and the central bank is set to decide to start scaling down its net asset purchases during the autumn. We expect the above-target core inflation to prove quite sticky and see the Fed starting a rate-hiking cycle in the second half of 2022.
The ECB, in turn, opted for a symmetric 2% inflation target during the summer and changed its forward guidance in a more dovish direction, raising the bar for rate hikes. With the modest Euro-area inflation outlook, we do not see any ECB rate hikes even over our extended forecast horizon until end-2023. The pandemic-era bond purchases are still likely to be concluded during the first half of 2022, but the central bank will continue to buy a significant amount of bonds via its other purchase programmes. The ECB’s actions continue to exert significant downward pressure on bond yields and are likely to keep longer real yields in negative territory throughout our forecast horizon.
The significant fall in long bond yields during the summer illustrates that there are still obstacles preventing a more significant rise in yields, even amidst a recovering economy. While the changing Fed policy and accumulating inflation pressures will favour higher US yields, the structurally lower long-term rate levels will likely act as a brake on rising long yields.
There are upside risks, however, especially if the high inflation in the US proves even stickier than we think and financial markets start to question the Fed’s ability to keep inflation pressures contained.
FX: Our conviction in a stronger USD has increased
EUR/USD has made several unsuccessful attempts at breaking below 1.17, but the FOMC July meeting minutes finally managed to push the currency pair below that level, which has helped to increase our conviction in a further move down for the cross. We target levels around 1.10 over the forecast horizon and expect the bulk of the move to happen sooner rather than later in conjunction with the launch of the tapering process.
We always like it when there is no “policy resistance” to our FX view, and that currently seems to be the case for EUR/USD. Would the Fed be annoyed with a lower EUR/USD reading? Not really, as it would then be able to partly export the current overshoot in (supply-side) inflation. Would the ECB be annoyed with a lower EUR/USD reading? Not at all, as a lower reading would be helpful in bringing EUR inflation to or above 2% as wished for. This leaves decent room for a move lower in EUR/USD, also as positioning in the market is not yet USD heavy.
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