1. Economic expectations are improving, with the world economy expected to rebound strongly this year and next, as the successful roll-out of vaccines triggers pent-up spending demand, allows firms to re-employ more people, and as previous policy stimulus feeds through. The latest sign of this was the upward revision by the International Monetary Fund (IMF) to its economic forecasts.
At its annual spring meetings, over the last week, the IMF said the world economy is likely to have contracted 3.3% in 2020 and is expected to grow by 6% this year and 4.4% next. Last October, at its annual meetings, the IMF’s forecasts were much weaker: -4.4% (2020) and 5.1% (2021), and last June it was even more pessimistic.
2. There will be significant variation in growth across regions and countries. Last year, the vaccine gap held growth back. Now, the vaccine roll-out is a key trigger for when countries can rebound. Thus, there is significant regional variation in growth prospects. China, Asia and the US look set to lead the global recovery. In contrast, while Western Europe will recover, its rebound will be later and weaker.
3. The UK looks set to grow very strongly this year, and next. Consider these forecasts for UK growth: the Office for Budget Responsibility (OBR) expects UK growth of 4% (2021) and 7.3% (2022); the Bank of England expects 5% (2021) and 7.25% (2022); the IMF revised up its view of UK growth to 5.3% for 2021 and 5.1% for 2022. We expect UK economic growth to be around 7.75% this year and 5.2% next year.
4. The policy stimulus has been huge, both here in the UK and globally. Central bank rates are at all-time lows. Global public debt levels are at all-time highs. Alongside the post Covid rebound, such stimulus explains why a key focus in financial markets has been on “reflation”. This has helped underpin equity markets but it has triggered expectations of rising inflation and fears of much higher inflation, thus pushing bond yields up, too.
5. There is uncertainty and there are risks. Uncertainty is a word heard frequently. That is because it is not certain how people or firms will behave as they emerge from the pandemic. Also, while the prospect of vaccinations triggering a rebound – helped by policy stimulus – is positive for the UK and the global economic outlook, there are noteworthy risks: (a) renewed health risks because of mutations of the virus; (b) economic data disappoints because people and firms prove cautious; (c) policy mistakes, because governments or central banks prematurely tighten policy or make misplaced comments that spook financial markets; (d) inflation fears materialise; (e) another shock hits – geopolitics would seem the most likely source.
6. Not everyone will emerge from the pandemic in good shape. Last year, the UK economy’s performance varied across sectors. Some parts of the economy have been moribund: tourism, restaurants, the arts and creative sector. While the good news is that payrolls have risen for the last three months, they are still down 693,000 on a year earlier. The unemployment rate is 5% versus 3.9% pre-pandemic. The numbers unemployed are 1.7 million. There were 4.7 million people on furlough in January, and while many of those will return to work (for instance, 938,000 retail workers are on furlough as are two out of three in the restaurant sector), it is likely that unemployment will rise further, possibly peaking around 2.5 million, an unemployment rate around 7.4%. While lower than once feared this is still high.
Also, many firms will emerge from this crisis nursing debts. Total business loans made available during the pandemic were £73 billion and these need to be repaid. Thus, while the economy looks set to rebound, there will be scarring and longer-term effects for many.
7. Inflation may be higher and more volatile during this economic recovery. As demand rebounds, supply bottlenecks may become evident and some firms may also take advantage of this recovery to rebuild profit margins. The scale of monetary stimulus has also triggered higher inflation expectations, particularly in the US, where monetary growth accelerated sharply last year. The rise in bond yields and other market views of inflation reflect this.
Much depends upon wage growth, too. In the UK, pay is rising by an annual rate of 4.2% (excluding bonuses), although the Office for National Statistics notes regular pay is up 2.5% versus current inflation of 0.4%. Despite the possibility of slightly higher inflation this year and next, there are many structural drivers that look set to suppress longer-term inflation, including intense global competition and the ongoing digital and data revolution.
8. Globally, stronger growth is needed to address debt concerns. To make global comparisons let’s use the IMF’s Fiscal Monitor, just released this week. In 2021 it sees global gross debt at 98.9%, with advanced economies at 122.5% and emerging economies at 65.1%. Only two years ago these figures were 103.8% and 54.7%, reflecting the extent to which tax revenues have suffered and how much governments have provided necessary support during the pandemic. Unfortunately, the net debt figures are also very high, at 86.3% globally.
Consider here the figure for net public debt as a proportion of GDP (so in relation to the size of their economy) for each G7 country for 2021 compared to 2007, the year before the global financial crisis (the 2007 figures are in brackets): Canada 37.0% (23.1%); Germany 52.5% (58.4%); UK 97.2% (38.3%); US 109% (42.3%); France 106.1% (54.1%); Italy 144.2% (101.2%); Japan 172.3% (81.5%).
9. Significant fiscal policy challenges lie ahead. The debt figures above highlight the extent to which the global financial crisis and the pandemic have pushed public debt higher. If a country’s level of debt to GDP is above 100% then it risks falling into a debt trap if its rate of economic growth falls below the interest rate it is paying on its debt. It is like maxing out on a credit card and not being able to pay the monthly interest rate bill. Very high debt levels leave a country vulnerable to painful policy choices if growth weakens or if interest rates soar.
The ideal way to reduce debt to GDP is strong economic growth. Then governments need to be patient, or they have the choice to raise taxes, cut spending, to borrow, or a combination of these. It is only next year, once economies have rebounded, and inflation and yields have settled, that we will get a better gauge of any fiscal challenges ahead.
10. Monetary policy is now intertwined with fiscal policy. There is a need for monetary and fiscal policy to be aligned, but the extent to which central banks are now buying government debt is a concern. The Bank of England is now the largest holder of UK government debt. Here in the UK this has lessened the maturity of UK debt considerably, so much so that higher rates pose a far bigger worry than previously. Fortunately, for governments, including the UK, there is still ample demand in a low inflation and low policy rate environment for gilts and other public debt.
11. One of the main focuses for financial markets is how central banks will exit from their cheap money policies. The focus of financial markets is, naturally, upon the US Federal Reserve Board (the Fed). Thankfully, the Fed has been consistent in its recent communications, thus managing market expectations. While it foresees recovery it has been keen to balance expectations by highlighting risks. Also, while it foresees some inflation volatility, it expects any rise in inflation to be transitory. Moreover, the Fed is now opting for a two per cent average inflation target and thus they are prepared to see inflation above its two per cent target without being pushed into tightening.
Thus, the Fed looks set to continue with its asset purchases and to keep policy rates low for some time. As recovery prospects have improved, the market is now speculating on whether the Fed may hike rates next year (2022) having previously expected rates to stay low and unchanged until 2023. The Fed’s forward guidance is important and points to no premature or unexpected policy tightening.
12. Green means growth. Just over a decade ago I joined the Advisory Board of the Grantham Research Institute on Climate Change and the Environment at the London School of Economics and Imperial College. At that time, the body of opinion was that addressing environmental issues should be secondary to growth, and that taking action might be too costly to justify.
Now, thankfully, things have changed, and there is greater acceptance that addressing green issues can go hand-in-hand with economic growth. Patience is still needed, as things can’t change overnight and policies need to be sensible, but the move towards net carbon zero economies is significant. Now, financial markets need to help deliver a far greater suite of environmentally friendly assets in which people can invest.
Please note, the value of your investments can go down as well as up.
