Executive Summary

• Global growth remains strong but increasingly uneven amid evolving virus dynamics and the gradual removal of policy support. Growth momentum softened over the summer despite a positive impulse from trade. The delta-related uncertainty and soft stops will cost (only) -0.2 to -0.5pp of GDP growth in advanced economies in 2021. Overall, while we expect global growth to remain strong at +5.5% in 2021 and +4.2% in 2022 amid significant monetary accommodation and fiscal impulse, economic slack remains sizable with significant variation across countries. Vaccination rates, unwinding of supply bottlenecks and policy choices will critically influence the scale of catch-up. Output will remain below its potential level until the end of 2022, and the output loss relative to the pre-crisis trend is likely to be considerable, especially in Emerging Markets, where scarring tends to be higher. Their recovery continues to lag because of undervaccination and less room to manoeuvre for additional policy support, as well as the Chinese slowdown. Inflation is likely to accelerate this year as the recovery becomes entrenched, mainly reflecting transitory factors that are likely to wane early next year. While inflation expectations remain well-anchored, pockets of elevated inflation are visible in some sectors with stronger pricing power (automotive, building materials, and, to some extent, in retail and warehouse services). Overall, we expect inflation to reach 2.2% in 2021 and 1.5% in 2022 in the Eurozone and 4.1% and 2.2% in the US, broadly in line with the respective inflation targets.
• Price and capacity pressures on global trade are likely to persist going into 2022, albeit less acutely. The reopening boost to services has eased, while labor and materials shortages are weighing on manufacturing and construction. Supply-chain disruptions worsened over the past few months and triggered a more visible manufacturing slowdown during the summer, which could amplify adverse spillover effects to Emerging Markets. The rush for restocking amid historically high domestic production shortfalls and low inventories continues to accelerate the recovery in volumes and prices. While restocking should become less of a driver for trade flows in 2022, companies are likely to operate in a “just-in-case” environment as the normalization in shipping capacity is unlikely to occur before 2023. Hence, on the back of the frontloading in 2021 (+0.3pp to +8% in volume), we have revised slightly on the downside our 2022 forecast for global trade growth: -0.2pp to +6%.
  
• Risks to the outlook are broadly balanced, but pandemic-related uncertainty remains high. Higher vaccination rates, together with a stronger release of pent-up demand and a faster than-expected global recovery, could provide a stronger growth impetus. However, as long as vaccination rates remain below the coverage required to reach herd immunity and continue to differ significantly between most advanced and Emerging Markets, virus mutations will raise the prospects of renewed lockdowns and keep the recovery uneven. In addition, tighter financial conditions or a premature withdrawal of policy support could undermine the recovery and increase private and public sector vulnerabilities, with the potential for cliff-edge effects in some countries and further adverse distributional effects.
  
• Unwinding policy support requires a careful balancing act to ensure an effective rotation towards private demand and sustainable growth. The fiscal impulse in most countries remains positive, with both China and the US expected to remain expansionary while the Eurozone has delayed structural tightening due to the supplementary spending in France and Germany. While several Emerging Markets have already started tightening their monetary stance, most central banks in advanced economies have remained accommodative but normalization is on the horizon. U.S. Federal Reserve is likely to gradually pivot towards dialing back its accommodative stance, with stronger inflation and growth outturns suggesting economic slack diminishing more quickly than anticipated. Tapering is likely to commence later this year but uncertain virus dynamics and inflation pressures make it difficult to pin down the scale and timing. Capital markets have been unfazed by reemerging uncertainty about the pace of recovery, but risk sentiment underpinning historically high valuations remains crucially dependent on continued policy support. The existing pre-positioning by market players has reduced the downside risks of market disruptions and dislocations in capital flows, especially in Emerging Markets. Against the backdrop of a stabilizing recovery, we expect asset prices to move sideways over the near term as we enter a consolidation phase. Besides accelerating the vaccination rollout, the key policy priority is to calibrate support to the pace of the recovery, while gradually shifting to more targeted measures focusing on growing firms and sectors. Another important challenge is to identify the potential size of the reallocative needs and the role that policy should play in facilitating reallocation in response to the scale of structural transformation.

Extensive policy support has cushioned the pandemic’s impact on growth, but economic slack remains sizable as growth momentum softened over the summer. While massive job losses and bankruptcies have been prevented, labor participation has declined and private consumption and investment have only partially recovered, leaving output in Q2 2021 more than -2.5% below its pre-pandemic level in the Eurozone vs. -0.3% in the US. Unlike during the Global Financial Crisis, economic scarring has been greater in most emerging economies, most notably those dependent on international trade and tourism, and where policy space for support was limited. However, declining leverage from the rising cash holdings of both corporates and households augurs well for a rebound in investment and consumption once the outlook improves.

While global GDP growth is expected to remain strong at +5.5% in 2021 and +4.2% in 2022, the recovery is likely to be partial and uneven. Most countries will restore pre-crisis output, but it will remain below potential by the end of 2022. The cumulative output loss relative to the pre-crisis trend is sizeable and larger in countries with low vaccination rates. Especially in Europe, there is an increasing divergence across countries (Figure 1). Inflation is likely to accelerate this year as the recovery becomes entrenched, mainly reflecting transitory factors that are likely to wane in early-2022. Inflation expectations remain well-anchored.

The reopening boost to services has eased, while labor and materials shortages weigh on manufacturing and construction, most notably in China, which is experiencing a significant slowdown of its manufacturing sector. This adds on to the supply-chain disruptions since the start of the year, which have kept input prices and supplier delivery times at record high levels.

Figure 1: Real GDP growth forecasts

Figure 2: Real GDP levels

We have upgraded our global trade forecast for 2021 (+0.3pp to +8.0% in volume, and +1.0pp to +16.9% in value). The rush for restocking amid historically high domestic production shortfalls and low inventories continues to feed into the acceleration of both volumes and prices. We expect price and capacity pressures to remain going into 2022, albeit less acutely, and no normalization in shipping capacity before 2023. Hence, on the back of the frontloading in 2021, mainly driven by supply-chain disruptions, we have revised slightly down our 2022 forecast by -0.2pp to +6% in volume and by -0.4pp to +8.0% in value terms.

Figure 3: World trade growth forecasts

Most of the recent strong rebound in inflation is likely to be temporary and largely explained by supply-side constraints and base effects. However, the re-opening of economies after a series of lockdowns has increased the uncertainty about the scale and duration of the current surge of headline inflation. In advanced economies, labor shortages may increase inflationary pressures, notably if partial unemployment schemes are not withdrawn completely by year-end and labor participation remains depressed due to some structural transformation resulting in prolonged resource reallocation during the recovery phase. In Europe and the US, some wage pressure could be building as real wages have not kept pace with productivity gains (see Figure 4), suggesting that the non-labor unit cost of businesses is causing inflation as firms cope with higher input prices by preserving mark-ups. However, a sustainable revival of the wage-price loop seems unlikely amid considerable economic slack. Unemployment rates are expected to rise by year-end and money velocity struggles to accelerate despite the strong rebound in growth. Overall, we expect inflation to reach 2.2% in 2021 and 1.5% in 2022 in the Eurozone and 4.1% and 2.2% in the US, broadly in line with the respective inflation targets. In fact, month-on-month, price pressures have started declining already.

Figure 4:Real wages and productivity gains (US, Eurozone)