Macro forecasts: charts and commentary

US

The US economy expanded somewhat less rapidly than expected in Q2, as the impact of the Delta variant led to a slowdown in service sector activity. That likely extended into the start of Q3, but with cases once again falling and vaccination rates rising we expect that lost activity will be recovered in Q4 and 2022 Q1. The labour market has continued to strengthen and is on course for the unemployment rate to fall below the pre-Covid historic low in 2022.

Looking further ahead, the expansion should be further supported by the expected passage through Congress of a large public infrastructure package, alongside a range of income redistribution policies, in Q4 2021. Perhaps the most challenging aspect faced by the economy in the near term is the supply-chain disruption that has led to elevated inflation in a number of specific areas. We expect that to be transitory, but the risk of a more protracted period of elevated inflation has risen. As a result, the Federal Reserve may need to bring forward the first rate hike into 2022, a little earlier than we had previously anticipated.

Figure 1. US

Euro zone

In customary fashion, the Euro zone managed to manufacture two (technical) recessions from the COVID crisis, where most nations experienced only one. Activity recovered sharply in Q2 and is expected to record further robust increases in the second half of the year.

We expect ongoing above-trend growth (albeit at a successively lower pace) to be maintained throughout 2022 as the post-pandemic catch up continues. Our latest projections indicate that the level of GDP by the end of 2022 will be very close to where it would have been if the pre-COVID trend had been sustained.

Given the scale of the shock, that would be a remarkable achievement and one that suggests minimal lasting damage. This is a far more optimistic outlook than those which have prevailed over much of the last year and a half. Although inflation has spiked higher, the ECB, like other central banks, is expected to 'look through' higher readings, which it considers will be transient. QE will come to an end, but the first rate hike still looks a long way off.

Figure 2. Euro zone

UK

The 1.6 per cent fall in GDP in Q1 was a little less than feared, a reflection of the now well-defined trend around the world of COVID restrictions having much less of an adverse impact on activity than they did in 2020.

The resilience and adaptability of households and businesses has been impressive and beneficial. Moreover, UK GDP rebounded very strongly in Q2, rising by 4.8 per cent. Although growth is expected to slow in the second half of the year, robust quarterly rises of two per cent or more are expected, which would take GDP back to its pre-pandemic level by the end of the year.

Attention has now turned to inflation which has risen sharply and is likely to push higher still. With supply-demand imbalances more intense in Britain because of Brexit adjustments, inflationary pressure here could be more stubborn. The Bank of England has acknowledged this with a more hawkish stance and financial markets have responded by pencilling in earlier rate rises. While this is clearly a risk, we continue to believe that the BoE will be patient – they believe most of the inflation impulse will be temporary.

Figure 3. UK

China

China’s growth hit some major speed bumps in Q3. The government’s zero-covid policy is harsher than most countries, and despite disseminating two trillion vaccines, there does not appear to be acceptance that COVID is endemic.

Meanwhile, exports are very strong, soaring to around 25 per cent above pre-crisis levels. However, industrial production and fixed asset investment are slowing while consumption has still not fully recovered; limits on coal-fired power and dirty metal output to meet carbon goals, while demand for electricity has soared, is also causing pricing and growth problems that are not unique to China.

What is new are the aggressive new policies towards certain sectors that are not aligned with President Xi’s longer-term agenda. Containment of leverage is slowing credit growth, but has become disruptive as several large property firms implode. Beijing is expected to counteract the slowdown with fiscal, but it also needs to contain contagion to the financial and property sectors. Rising inflation and the desire to deleverage and decrease financial risks should keep the PBoC from large scale easing, but the central bank will retain an easing bias and ample liquidity provision.

Figure 4. China

Japan

After Fumio Kishida prevailed in the LDP election, continuity should prevail when he becomes the Prime Minister, following the Lower House elections later this year. Reform and raising productivity are likely to play second fiddle to recovering from the coronavirus restrictions, with income redistribution via tax hikes, tax breaks, and fiscal stimulus being the government’s likely main focus.

Growth has been held up by exports and investment, and a return to more normal conditions should help consumers start to spend more in Q4 and into 2022; by the end of next year pre-crisis GDP should be attained with around three per cent annual growth; after that catch-up, growth will fall to one per cent or less and investment will still flow out rather than in.

Headline CPI may be boosted by energy and food prices temporarily, but the longer-term trend is near zero; this will allow the BoJ to monetize fiscal deficits with QE purchases, negative rates, and yield curve control; divergence with global growth and monetary policies should weaken the yen marginally, but strong balance of payments and returns on external assets may act as an offset.

Figure 5. Japan

Canada

Uniquely among the G7 nations, Canada experienced a dip in GDP in Q2, although the small decline (-0.3 per cent) needs to be seen alongside the strong increases previously. July numbers remained fragile, but survey readings have picked up subsequently, so Q3 overall should see a rise in activity that will more than offset the Q2 fall. With the US set to remain strong, oil and commodities doing well and global trade continuing to revive, Canadian growth should be well supported.

As elsewhere, the Bank of Canada is presenting a fairly relaxed stance against the backdrop of higher inflation. Even so, they have signalled a willingness to tighten policy a little more quickly or earlier than other developed market central banks and have already reined in asset purchases significantly. Financial markets are currently discounting two rate hikes from the BoC over the next year.

The snap General Election called by President Trudeau passed with virtually no change in either voting patterns or representation. There will be a similar minority Government to the one that has existed for the last two and half years. Discretionary fiscal policy is unlikely to change.

Figure 6. Canada