Optimistic on global economic growth
As a result of the rapid roll-out of Covid-19 vaccines in some parts of the world and substantial fiscal stimulus, we are optimistic about the global economic outlook. However, we continue to see differentiation:
- In the eurozone and UK, we expect a more dynamic and sustained rebound. Although the vaccine roll-out has been slow in the eurozone initially, we think it is accelerating and the fiscal policy response overall has been prompt and sufficiently well calibrated.
- Our US forecasts have been raised due to the Biden administration’s more aggressive fiscal plan and rapid vaccination roll-out. We believe this will set the stage for the US economy to surpass pre-pandemic levels by Q2 2021.
- We are more cautious on China and expect growth to slow over the next few quarters. While the release of pent-up consumption demand and export could exceed expectations, the vaccine roll-out might disappoint, leading to financial risk control triggering credit tightening.
Overall, we envisage a strong rebound over the next few quarters, leading to an earlier return to pre-pandemic levels than we previously forecast and than the consensus expects.
Narrowing gap between the eurozone and the US
In our view, Europe has the greatest room to exceed consensus growth expectations, powered by an accelerating vaccine programme and supportive policy mix. Moreover, we expect the ECB’s reassessment of its policy framework and the EU’s progress towards more flexible fiscal rules to keep policy supportive for a prolonged period and sustain the rebound in eurozone growth.
We think general perceptions underestimate the chances of eurozone inflation hitting 2% on a sustainable basis in the three- to five-year horizon. We expect EUR long-term yields to catch up with US long-term yields by H2, the EURUSD rising trend to resume, and European equities to strengthen.
Widening gap between EM and DM monetary policy
While our stronger growth outlook reinforces our reflationary views, we think the reaction functions of the US Federal Reserve and the ECB remain asymmetric, with both waiting to see inflation on a sustainable basis before tightening policy. We expect central banks in developed markets to maintain this asymmetry to the news flow, responding decisively to any downward shock and more cautiously to positive news on growth and inflation. This will be an opportunity for them to limit deflationary risk in the future.
In contrast, some emerging market countries have already tightened monetary policy and we expect a bigger wave of rate hikes ahead in Latam and CEEMEA.
We see three reasons for the emerging market – developed market gap:
- Pressure from commodity prices, particularly food.
- Inflation expectations being less-well anchored in EM than in DM.
- Central bank reaction functions, with EM central banks maintaining traditional inflation-targeting in contrast to the flexibility adopted by the Fed and other DM central banks.
Reflation in the medium term
In essence, we think a mix of ingredients will prove reflationary in the medium term:
- higher prices due to temporary factors and hence higher inflation expectations;
- quicker slack absorption due to both stronger demand and negative supply shocks; and
- accommodative monetary policy.
Recent developments, including higher oil and commodity prices, evidence of supply disruption and a fiscally-fuelled recovery, support our reflationary view, which is reflected in our forecasts for higher breakeven inflation in both the US and Europe over the next nine months.
We think there is scope for eurozone inflation expectations to catch up with the US once the recovery gains momentum in the second part of the year, and we expect the ECB to move in a decisively dovish direction with its strategy review set to conclude in September.
In emerging markets, we now foresee headline inflation peaking higher this year than we previously thought.
Europe continues to lead in sustainable finance
With the Sustainable Finance Disclosure Regulation (SFDR) that came into force early March and the ECB’s strategy review to include sustainability measures, Europe has clearly taken the lead on regulation and policy in this space.
The relevance of climate change to the ECB’s price stability mandate is likely to result in two sets of measures in its strategy review:
- Protective approach: At a minimum, we expect the ECB to require the disclosure of climate risks for all assets it accepts on its balance sheet. As well as protecting its balance sheet from climate change-related risks, the ECB would use its pivotal position in the financial system to further the disclosure of such risks in order to help the market price them more adequately.
- Proactive approach: The ECB is also likely to deviate from market neutrality in its corporate asset purchases by underweighting issuers with higher climate-related risks.
This strong EU regulatory power is likely to boost sustainable investing, impacting equities, rates, and certain sectors such as energy.
Finally, we expect green bond issuance to grow by 50% in 2021, led by European issuers.
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