Macro monthly Dec 2021 | Central Bank challenges to policy normalisation | Article – HSBC VisionGo

Central Bank challenges to policy normalisation
Finance  ·    ·  7 mins read

  • The pandemic, high inflation and the unusual behaviour of labour markets…
  • …are among the challenges facing major central banks as they start to normalise policy
  • We recently edged up our global GDP growth forecasts to 4.1% in 2022 and 3.2% in 2023

Normalisation, but not as we know it

The global economy is heading into 2022 in a better place than we might have expected a year ago. COVID-19 vaccines have been rolled out in large parts of the world, there has been a robust economic recovery and much less medium-term scarring than we anticipated when the pandemic began.

Inflation is at multi-decade highs in the US and Europe

However, things are still far from normal. The battle against the virus continues, with Europe re-imposing restrictions to slow the spread of the highly transmissible Omicron variant. Supply chain bottlenecks, higher energy and food prices, surging consumer demand and higher wages have sent inflation in the US and Europe to multi-decade highs. The hopes of this time last year that inflation would be ‘transitory’ have faded.

Jobs, wages and inflation

Many advanced economies are facing worker shortages

Labour markets have also changed since the pandemic. The US, the UK and many advanced economies face worker shortages and low labour market participation. Fewer older workers returning to employment, other priorities (such as care-giving, education and personal health), and a bigger financial cushion from asset price gains and fiscal stimulus payments are factors, many of which will not be permanent.

Firms may automate more to counter labour shortages and rising wage pressures

These will likely normalise at different rates, so the risk of higher wages could grow: currently it is only the very low-paid, low-productivity leisure sector that is seeing wages rise in real terms in the US. The continued rise in US capital spending, particularly tech, signals firms are looking to automate more, which is hardly surprising given the labour and skills shortages, and rising pay demands.

Inflation is a focus for developed market central banks

Inflation is now a key concern for developed market central banks. The December meeting shows that the Federal Reserve will try to avoid letting inflation run too hot for too long. They are stepping up tapering and now project three rate rises in 2022. The Bank of England (BoE) has also started to raise rates while the European Central Bank (ECB) plans to end its emergency bond purchases in March and scale back the regular asset purchases thereafter.

Asia to fare better than other emerging markets

Whatever the Fed and other major central banks do will have big implications for the emerging economies, which already face a challenging backdrop from the pandemic, a stronger dollar, and a slowing mainland China. Many emerging economies are, at least, better prepared for gradual interest rate rises than they have been in the past.

There is more room for catch up for consumption in Asia

We still think Asia will fare better than other emerging regions, even if the outlook is far from stellar. Exports will inevitably be less supportive, but there is more room for catch-up on the consumer side than in other emerging economies where consumption is already above pre-pandemic levels. The investment outlook is also bright, with foreign domestic investment inflows having held up surprisingly well and a bigger push towards green investment in China.

Some parts of Asia may need to lift rates by mid-2022

Asia’s low inflation rates are set to creep higher in 2022 as consumer spending improves, but should remain lower than in other emerging markets, implying less of a squeeze on real wages. There has not yet been much monetary tightening in Asia and, although mainland China has just signalled a shift in policy in favour of supporting growth, by mid-2022 we think that some modest rate increases will be appropriate for domestic financial conditions in some other parts of Asia.

Our GDP growth forecasts

We forecast global GDP growth of 4.1% in 2022

Given the many moving parts in play, there is huge uncertainty about the outlook for next year and beyond. We anticipate some easing of bottlenecks, and an increase in labour participation – but this could take a while, and with uneven progress across different economies. Our forecast for global GDP growth in 2022 was recently raised slightly to 4.1% (from 4.0%). Downgrades to the eurozone, Russia, Brazil and others are offset by upgrades to many economies in Asia-Pacific, notably India. We edged up our global GDP growth forecast for 2023 to 3.2% from 3.0% thanks to marginal upgrades to the US and the eurozone.

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