Developed economies are expected to continue their strong post-lockdown bounce back in the second half of the year. Vaccine rollout is well advanced in the US and UK, and continental Europe is quickly catching up. Despite recent spending, we estimate that households still have considerable excess savings as we head into the second half of the year, amounting to about 12% of GDP in the US, 7% in the eurozone and 10% in the UK.
Not all sectors of the economy are returning to normality: travel restrictions are likely to remain in place until governments are more confident that vaccination levels can cope with new strains of the virus. However, consumers are spending where they can and tourism’s loss appears to be home renovation and construction’s gain. Housing markets are booming in much of the developed world.
For now, it is rising consumer prices, rather than house prices, that central banks are monitoring. After over a year of pandemic-related disruptions, supply is struggling to keep pace with surging demand. Alongside soaring global commodity prices, input costs are on the up, with many companies passing cost increases on to end consumers. US CPI inflation is likely to remain above 3% into next year, and eurozone and UK inflation also looks set to rise in the coming months (see On the Minds of Investors: Monetary and fiscal coordination and the inflation risks).
Central banks believe these inflationary pressures will prove transitory. Whether this turns out to be the case depends in large part on the behaviour of labour markets. If workers are able to bargain for higher pay, inflationary pressures will become more entrenched.
Unfortunately, labour markets are as hard to predict as goods markets at this point. For example, in the UK, the unemployment rate has risen to 4.7%, but is well below the 8.5% peak it reached following the Global Financial Crisis. But 8% of the workforce are still on furlough, making it hard to gauge the true degree of labour market slack. In the US, the unemployment rate did rise sharply and, at 5.8%, still sits 2.3 percentage points above the pre-pandemic low. And yet firms are saying they are having more difficulty recruiting than at any point on record (Exhibit 1).
Exhibit 1: Firms are finding it hard to find workers which may increase wage pressures
US NFIB jobs hard to fill and plans to raise workers’ wages
Inflation is likely to create market jitters in the second half of the year, but ultimately we believe it will take a lot to shift the central banks away from their current preference for tightening too late, rather than too early. Talk of tapering by the Federal Reserve (Fed) will no doubt become louder over the summer, but our base case sees a reduction in asset purchases beginning only at the start of 2022, with rate hikes not until at least the following year. In the eurozone, large asset purchases are set to continue for a long time in the context of still subdued inflationary pressures, even if we see some shuffling of purchases among the European Central Bank’s (ECB’s) various purchase programmes. Recent commentary from the Bank of England (BoE) suggests that policymakers may be open to tightening policy a little more quickly in the UK, but it should still be a debate for next year rather than this.
This new, more patient reaction function from the central banks is not without risks. A willingness to let the economy run hot sets up a strong near-term rebound. Yet, once the time for rate hikes arrives, we see a risk that central banks (especially the Fed) will have to tighten policy more quickly than the market currently expects.
Supportive policy from developed world central banks will help emerging economies catch up. While some economies, such as China, came through the pandemic relatively quickly, others are still struggling to contain the virus. However, we expect the vaccine delay in key parts of the emerging world to be a matter of quarters rather than years, and believe economic activity should prove relatively resilient given the strength of global goods demand and commodity prices.
Overall, we think the outlook for near-term global growth remains strong. As the bounce from pent-up consumer spending fades, we expect government and business spending to pick up the baton. Focused on ‘building back better,’ governments are lining up multi-year infrastructure projects. This marks a stark contrast to the last cycle, in which government austerity proved a consistent drag on activity and inflation (Exhibit 2).
Exhibit 2: Fiscal policy will remain supportive to growth in stark contrast to the austerity of last cycle
UK public sector wage, employment and real investment growth
It is also remarkable to see how quickly investment is bouncing back, again in stark contrast to the last cycle (Exhibit 3). Indeed, if inflation is the greatest downside risk for investors to monitor, investment spending is the key upside risk, since it could potentially herald the start of a new era for productivity growth and help alleviate inflationary pressures.
Exhibit 3: The remarkable pick up in investment should support growth in the near term and beyond
Developed market real investment
Overall, the macro backdrop for the second half of the year remains strong. Growth in the developed world may slow by year end, but is likely to remain above trend, broadening out to investment spending and becoming more evenly distributed across geographies. Inflation concerns are likely to linger, but ultimately we think it will take a lot of bad news for central banks to meaningfully alter their current plans for a glacial removal of stimulus. While this approach may create further risks down the road, economic activity and corporate earnings look well supported for now.