Regional forecast snapshots
United States: Expect the fastest growth in almost 40 years
Tiffany Wilding and Allison Boxer
We expect U.S. real GDP growth to exceed 7% in 2021, as massive fiscal stimulus combines with an improved public health situation to create a surge in economic activity. Though off a low base, this would be the fastest pace of U.S. real GDP growth since 1984. COVID-19 vaccinations are now well underway, consistent with our expectation that the majority of the population will be vaccinated by the end of the second quarter. The additional COVID-19-focused fiscal stimulus that passed in December and March amounts to nearly $3 trillion and is estimated to contribute 2.5–3 percentage points to 2021 real growth. We expect growth to decelerate meaningfully in 2022 to 3%, but remain above trend, as the sharp decline in the fiscal impulse is offset by continued reopening and recovery.
Despite this bright growth outlook, we have only moderately upgraded our inflation outlook for 2022 and beyond. While we expect a period of elevated inflation in the second quarter of 2021 due to base effects and price volatility for COVID-sensitive sectors, we continue to see core consumer price index (CPI) inflation ending 2021 around 1.7% year-over-year and accelerating only gradually to 2.2% y/y by year-end 2022. Our near-term inflation forecast is muted because we believe there is still significant slack in the U.S. economy and it will take time for stronger growth to affect prices.
We expect the Fed to slowly reduce the level of monetary policy accommodation by tapering asset purchases in late 2021 or early 2022. However, we continue to expect a prolonged period before the Fed raises rates. Fed officials have clearly indicated they need to see a complete and inclusive recovery in the labor market and inflation sustainably at 2% before raising interest rates. According to our forecasts, and according to the Fed's own March 2021 forecasts, the Fed won't reach these goals until at least 2023.
Real GDP growth above 7% has only happened in the U.S. a few times over the past 50 years. Nonetheless, we think the risks around our outlook are balanced. On the upside, strong pent-up demand could spur an even faster drop in household savings than we anticipate. On the downside, new virus variants could significantly derail the recovery. The outlook for U.S. fiscal policy is also highly uncertain: Our baseline assumes the U.S. passes an infrastructure package, partially offset by modest tax hikes, but the details and likelihood remain unclear.
Euro area: Accelerating vaccinations to drive economic rebound
After a disappointingly slow start, vaccinations in the EU look set to gather pace from the spring, as supply from existing vaccine suppliers improves and new vaccines come online. We expect the more vulnerable populations – the elderly and healthcare workers – will be immunized by late Q2, a time at which European economies can start to emerge from winter lockdowns in a more sustained way. Economic growth at this point should accelerate briskly, but full normalization will take time given a gradual removal of restrictions, lingering caution, and some scarring effects from the crisis. We see euro area activity reaching its pre-crisis level in the first half of 2022, and we forecast GDP growth above 4% in 2021 and nearly 5% in 2022.
As for inflation, we anticipate a lot of volatility over the coming eighteen months, driven in good part by distortions from tax changes and CPI basket weight changes. But, beyond these distortions, we see inflationary pressures remaining muted given ample slack in the economy. We see core inflation averaging below 1% in both 2021 and 2022. In this context, the ECB looks set to remain supportive, keeping rates unchanged and continuing to add to its asset purchase program through the end of 2022. Fiscal policy also looks set to remain stimulative – helped in part by EU Recovery Fund disbursement from midyear 2021 – though orders of magnitude less than in the U.S.
We see risks as broadly balanced around the projections. The key upside risk is a greater release of pent-up demand as economies reopen, while key downside risks concern the speed and efficacy of vaccination programs and a greater degree of scarring in labor markets and companies heavily affected by the crisis. Fiscal policy could also be a swing factor for the outlook, though mostly beyond 2022, as European fiscal rules look set to remain suspended next year.
United Kingdom: Playing catch-up
The vaccine rollout in the U.K. is off to a quick start, and the government is on track to remove most restrictions by early summer. We expect activity to rebound fairly quickly from the second quarter, gradually catching up with activity in the rest of Europe, having fallen more sharply in 2020. We do not expect the U.K.'s departure from the EU to have any major economic effects in our baseline outlook for 2021 and beyond. Fiscal policy, meanwhile, is likely to mechanically turn contractionary in 2021 and onward, as COVID-related emergency measures gradually roll off. On balance, like in Europe, we see U.K. GDP returning to its pre-pandemic level in the first half of 2022, with GDP growth of around 5% in 2021 and 6% in 2022.
U.K. inflation looks set to increase over the cyclical horizon, but like in Europe it will be a volatile journey, with changes to both CPI basket weights and tax policy adding some temporary noise. Distortions aside, we continue to see underlying inflationary pressures running below the Bank of England's (BOE) 2% target, still hindered by high levels of economic slack. We expect core inflation to average 1.3% in 2021 and 1.9% in 2022. In this context, the BOE looks set to gradually taper its asset purchases from summer 2021 onward and finish its net purchases by year-end. On policy rates, however, we think the BOE is unlikely to tighten policy ahead of the Fed, sometime beyond the end of the cyclical horizon.
The key upside risk is a sharper-than-expected rebound in consumption, driven by a faster normalization of the household savings rate. Downside risks relate to more severe pandemic-related scarring, especially in the labor market.
Japan: Looser yield curve control
We expect Japan's GDP to grow 3% in 2021 mainly due to large fiscal stimulus (around 4% of GDP) and private domestic demand gradually normalizing after a sharp decline in 2020. With vaccine distribution likely to be slower than in other major countries, the recovery phase is also likely to be slower, but momentum should extend into 2022. We see risks as broadly balanced with potential downside risk coming from delays in vaccine and upside risk coming from a stronger-than-expected recovery in private sector demand.
On inflation, we expect Japan's headline CPI to remain below 0% in 2021 despite the recovery in growth. One-off factors such as the travel subsidy program and the mobile phone charge cut as well as a large output gap are likely to keep a lid on inflationary pressures over the cyclical horizon.
As achieving the 2% inflation target becomes even more remote, the Bank of Japan's (BOJ) easy stance is likely to be extended further. The BOJ conducted a policy review at the March 2021 meeting and made an effort to increase the sustainability of current monetary policy, which we believe could lead to further reduction in the amount of Japanese government bond (JGB) purchases to allow some market volatility once the COVID-19 situation improves as expected by mid to late this year. However, the BOJ is still likely to contain any sharp rise in yields within the 10-year maturity under the new 10-year JGB band at a 0% +/- 0.25% range.
China: Credit creation to moderate
We expect GDP growth in China to rebound to above 8% in 2021 from last year's low base, with consumption taking the lead. The 2020 recovery was mainly driven by policy-supported investment and strong external demand, of which the momentum likely will fade in 2021 as policy normalization starts and global manufacturing catches up. However, manufacturing investment likely will strengthen as business sentiment improves and the country refocuses on industry upgrading and supply chain security, while infrastructure and housing fixed asset investment (FAI) may moderate due to fiscal tapering and property market tightening.
The anticipated strong global growth rebound, thanks to vaccination progress and generous fiscal packages in many countries, has fueled commodity prices and will likely push inflation temporarily higher. But for China, the pass-through should be partly offset by pork price normalization as the sector recovers from the swine flu. Thus, we forecast headline CPI inflation likely will remain subdued and average 1%–2% during 2021. Macro policies should normalize at a gradual and moderate pace. The government has pledged no sharp policy turns in an effort to foster a solid recovery. However, risk prevention is regaining policymakers' attention. We therefore expect a moderation in credit growth and the fiscal deficit following the spike in 2020, with policy rates and the reserve requirement ratio (RRR) kept unchanged through 2021.
The downside risks in the near term include U.S.–China frictions, a sluggish recovery in consumption constrained by lingering public health concerns, and export underperformance as global competition resumes. Looking to upside risks, a brighter-than-expected global outlook and easing U.S.–China tensions could further boost China's recovery. Going into 2022, we expect a continued normalization of macro conditions, with growth returned to trend at 5%–6% y/y, and policies well-calibrated to balance growth with risk prevention. The new 14th Five-Year Plan (2021–2025) focuses on quality growth and productivity improvement, with an emphasis on innovations, domestic demand, income equality, and decarbonization.
Emerging markets: A multi-speed recovery
Our macro outlook for emerging markets is constructive, with marked differentiation in convergence speed driven by the pace of vaccinations, services and tourism recovery, the domestic policy stance, and the impact from higher commodity prices. Vaccination rollout and expected time to herd immunity in EM lags developed markets by about two or three quarters, with most emerging markets expected to reach herd immunity only by the end of 2022. Currently the UAE and Chile are leading, while Latin America (e.g., Peru) and some Asian economies (e.g., the Philippines) and those that have yet to secure vaccine supply are lagging behind. As a result, EM output gaps are forecast to close at differing speeds with large confidence intervals on the 2021 and 2022 BRIM growth forecasts of 6.6% and 4.0%, respectively (BRIM collective forecasts reflect the GDP-weighted average of forecasts for Brazil, Russia, India, and Mexico).
We expect BRIM inflation to rise in 2021 to 4.7% y/y due to a combination of base effects, higher food and commodity prices, and foreign exchange pass-through. In most cases, our end-2021 forecasts for EM economies are below the respective central bank inflation targets, but the risks are to the upside. Ongoing strength in commodities could add 2 to 4 percentage points to headline CPI, increasing risks of contamination of core inflation and possibly warranting a policy response. This alongside large output gaps and constrained fiscal/debt servicing costs means that monetary policy in 2021 will likely be even more complex and differentiated across EM than before. Over the cyclical horizon, we see Brazil and Russia hiking rates, South Africa and India staying on hold, and Mexico potentially easing further. At the same time, we expect 2021 fiscal balances to improve by about 2%–3% of GDP but the fiscal landscape to remain challenging for many countries, leaving limited room for further fiscal stimulus.
Other risk factors for EM are broadly balanced. Looking at the political calendar, there are key elections in Mexico where the incumbent party is expected to retain a majority. We expect fallen angel ratings and credit risks are confined to smaller EM countries with low index exposure, such as Romania and Colombia. And the increase in IMF special drawing right (SDR) allocations we expect to see in April 2021 could be positive for many high-yielding EMs with low reserve coverage.