The Year Ahead

Aside from this, there is now much more COVID immunity that's been built up by the world's population from prior infection as well as from vaccination. Initial studies of the Omicron variant certainly reveal lower vaccine effectiveness compared with previous variants but booster doses would appear to be highly effective in preventing severe disease and/or hospitalisation. New antiviral medications are also likely to be released in the coming weeks. Pfizer claims that its newly developed pill cuts the risk of hospitalization by early 90% if taken within three days from the onset of symptoms. The company has also indicated that its antiviral pills will be effective in treating the new strain.

So that's some good news and it should mean the world economy is in a considerably stronger starting position to cope with this new variant relative to prior strains.

But where does this now leave global GDP growth forecasts for next year? That latest Blue Chip consensus reveals that the generic answer is a normalisation toward more inflation-friendly levels. Super charged GDP growth rates were the norm in 2021 as economies bounced back from COVID disruption in 2020. There is now, however, far less scope for as big a bounce in 2022. However, reasonably high and above-trend rates of growth are still expected for the US, Euro Area and the UK. China in contrast is expected to see much-reduced - and arguably a sub trend - rate of growth next year (see figure 2 below).

Partly because of a much-reduced pace of growth that's likely to emerge from China, the risks to global growth forecasts are arguably tilted to the downside. China's sharp slowdown will weigh on world trade growth and could generate some financial stability issues next year. Still-high inflation, lingering supply-side problems, and ebbing policy support, could also generate more downside risks for the world economy next year not least if that last factor – namely fading policy support – ignites some stress in financial markets as well.

Figure 2: Blue Chip Consensus GDP forecasts for 2021 and 2022

Inflation should normalise as supply side congestion eases

What does that COVID and broader growth outlook though imply for inflation and monetary policy? The outlook here is more nuanced. On the whole US forecasters are expecting that current high levels of CPI inflation will drop back and normalise as supply-side congestion eases and policy support fades. China, Japan as well as the UK in contrast are expected to see higher average inflation rates next year, though to be fair inflation in China and Japan will start from a much weaker base relative to many other major economies. Their inflation rates in other words - just like in the US (and the Eurozone's) - are expected to normalise.

Figure 3: Blue Chip Consensus CPI forecasts for 2021 and 2022

In fact if we ignore the UK – which has a unique additional supply-side issue to contend with in the form of Brexit-related disruption – it's probably fair to say that global inflation – just like global growth - is also expected to normalise in the year ahead. And there are some good grounds for thinking that many of the drivers of higher inflation in recent months should lose some of their potency. These include a likely easing of global supply-side congestion as pandemic disruption fades, a weaker trend in consumer spending on goods (a key driver of higher goods price inflation in recent months) and ebbing support to growth – and inflation – from monetary and fiscal policy stimulus. On the monetary policy front more specifically and for the record most economic forecasters are also anticipating the start of a normalisation process in the period ahead (see figure 4 below for consensus forecasts for 3 month interest rates).

Figure 4: Blue Chip Consensus for 3 month interest rates in 2021 and 2022

Implicit in these forecasts for interest rates (as well as for the level of Central Bank asset purchases) is the idea that Central Banks need not step on the brakes too hard or too quickly. Indeed the risks to the interest rate outlook may still be tilted more to the downside than to the upside. That, in part, is a function of the view, stated above, that global growth risks are tilted to the downside. The other issue, however, that's of relevance to the interest rate outlook concerns the structural factors that are weighing down on so-called equilibrium real interest rates. These include still-high debt levels and ageing demographics, among others.

Rockier financial markets

As for financial markets the outlook here may be a little rockier as the valuation support from low real interest rates will probably ebb. Global equity market valuations still look quite rich, for example, relative to both their recent multi-year averages as well as the evolution of the incoming economic dataflow in recent months (see figure 5 below)

Figure 5: Global equity market valuations are quite high

That valuation support for stocks though as well as in truth a lot of the froth that we've seen in other financial markets of late owes a great deal to rock bottom – and indeed negative – global real interest rate levels. High investor leverage and limited scope for diversification have been consequences that may leave markets vulnerable to attempts by Central Banks to normalise policy. But with policymakers likely to normalise policy and at the very least taper asset purchase programmes this picture may change as real rates start climbing. There's no question in other words that financial stability risks loom large in the year ahead.

Figure 6: High equity valuations can in part be traced to low real interest rates

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.