Douglas Porter

December 17, 2021

In preparation for the annual look-ahead, it’s normally a useful exercise to also look back to a year ago, in order to see where the ship may have drifted a wee bit off the planned course. Amazingly, in light of the waves of uncertainty in 2021, the global economy came remarkably close to matching growth expectations, with China and Europe in particular landing right on top of forecasts. Precisely a year ago, we opined that “the global economy is expected to rebound 5.5% in 2021, and then advance another 4.0% in 2022” after the deepest plunge in the post-war era in 2020 (down more than 3%). In fact, we now estimate that the global economy snapped back 5.8% this year, and are penciling in 4.5% in 2022, before simmering down to 4.0% in 2023. To put those figures into some perspective, a typical year for the world economy in recent times would see growth just a bit above 3%. A keen observer would note that even with our call of a strong rebound in the coming two years that the level of activity would still be below its underlying trend by the end of 2023. Part of that shortfall reflects the simple fact that some of the loss on spending in the service sector in the past two years—such as on travel, entertainment, restaurants—may never be recouped.

But, similar to a year ago, our forecasts for the coming year are again shrouded in the relentless uncertainty surrounding the virus. The rapid spread of Omicron, and the associated restrictions already rolling out in many areas, cast a cloud on the near-term outlook. At the very least, the latest setback will throw sand in the gears of the global economy. Our best guess is that activity hits a serious air pocket around the turn of the year, notably in North America, before rebounding solidly through the middle portion of 2022. However, this is based on the ready recognition that there are still as many questions as answers on the new variant.

The other big cloud on the global outlook is hot inflation, and the need for policymakers to shift gears to cool prices. We would counter the caution with the point that there is also an upside risk to our growth projections, given immense pent-up demand for services, strong balance sheets among households and businesses, and the possibility of a bounce in some key sectors (e.g., autos) if supply chain issues improve.

China serves as a clear example of how forcefully things can bounce back as conditions return to something approaching normality. The world’s second largest economy was expected to snap back by 8% this past year, and it lived up to expectations. However, both retail sales and industrial production have cooled notably in recent months to around 4% growth, as the broader economy faces an array of new challenges. Amid a regulatory crackdown on various sectors, an over-extended and problematic property sector, and a drive to contain emissions, the growth backdrop has dimmed markedly. We look for China to ease back to 5.5% growth next year and then a new normal-like 5% in the following year. China’s consumer inflation has not jumped nearly as much as in other major economies, allowing reserve requirements to ease slightly heading into 2022, and we look for overall policies to loosen slightly next year.

Despite the second-half cooldown in China, the global strength in demand for goods drove a further rollicking recovery in commodity prices. After a V-shaped rebound from the depths of the pandemic in 2020, commodity prices jumped another 33% this year (Bank of Canada index). Alongside still-low interest rates and strong financial markets, solid resource prices supported emerging market economies overall. While there were some very specific cases of financial strains—Turkey, again—EM equity markets generally rallied further. However, the steep upswing in inflation prompted many to begin hiking interest rates, and aggressively so in some cases (Brazil, Mexico). Combined with ongoing challenges with the virus, some low vaccination rates, and a halting recovery in tourism, 2022 is expected to be tougher sledding for the developing world.

In the advanced economies, it was a year of stop-start activity, but with growth overall mostly living up to expectations, likely setting the stage for a repeat performance in 2022. However, besides having to deal with the uncertainty of Omicron, many economies will also be facing less generous monetary policy settings. Financial markets are not flashing signs of serious concern on either front yet, although the sustained negative long-term real bond yields are hardly a vote of confidence in the outlook. Curiously, after spending much of the year seeking to avoid a taper tantrum, central banks are instead faced with a late-year drop in bond yields—at least in part due to near-term growth concerns.

Our best guess is that activity hits a serious air pocket around the turn of the year, notably in North America, before rebounding solidly through the middle portion of 2022.

The Euro Area and the U.K. are facing their biggest virus wave yet, chipping away at the growth outlook. After a solid rebound of more than 5% this year, the Euro Area is expected to cool to around 4% growth in the coming year, and then a 2.5% advance in 2023. The U.K. has been hit with even bigger swings, and some severe supply issues of its own, on top of dealing with Brexit realities. Even so, the economy still managed to rebound by more than 6% this year, and is poised for 4% growth in 2022. With inflation pushing above 5%, this was enough to prompt the Bank of England to initiate the first rate hike (albeit just 15 bps) among the G7 central banks.

Elsewhere, Japan saw only a tiny recovery this year amid waves of the virus and the challenges in the auto industry. Its 1.5% growth rate came up almost 2 points below expectations at the start of the year, one of the biggest misses in the world. Given that nation’s weak underlying growth and the soft performance in 2021, we expect only a modest 2.5% advance, even with some improvement in auto output. Japan also stands out on the inflation front, with CPI still nearly flat from a year ago—even as almost all other major economies are dealing with decades-high price rises.

Australia also dealt with waves of restrictions this year after largely managing to keep the virus at bay in 2020, and even dealt with a true double-dip in the middle of the year. Still, the lucky country saw its jobless rate drop well below pre-pandemic levels (4.6% in November), and is poised for solid growth in the coming year. Even so, the RBA remains notably dovish versus others, a factor behind the 5% drop in the Australian dollar on the cross versus Canada in the past year. In February, the currencies were nearly at par, but the Aussie is now worth less than 92 Canadian cents.

The U.S. was the one major economy that actually handily topped growth expectations in 2021. A year ago, even our above-consensus call of 4.5% growth proved to be more than a point on the light side. The big story there unfolded very early in the year—when the Democrats won the Georgia Senate runoffs, and thus control of the chamber, the scales tipped on fiscal policy. Even as the Build Back Better bill struggles to navigate Congress, the Biden Administration did still manage to pass the huge stimulus package early in the year, as well as the large infrastructure bill later in 2021. The former helped fire up the consumer in March, and spending never looked back.

However, we would strongly assert that the massive fiscal dollop also played a major role in firing up inflation. With headline CPI running at 40-year highs of nearly 7% in November, the Fed turned quickly, and announced this week a plan to end QE by March. In turn, this sets the stage for rate hikes by mid-2022, if not sooner. After a roaring 5.6% advance this year, we look for GDP to cool to 3.5% next year and then closer to trend at 2.5% in 2023. Our call is a bit below consensus, and is in spite of expected fiscal support, as tighter monetary policies and ongoing virus uncertainty are expected to contain activity. In contrast to being on the low side of growth expectations, we remain relentlessly on the high side of inflation expectations, calling for U.S. CPI to post an average annual increase of just over 5% in 2022 before calming below 3% in the following year.

We have also tweaked our call on Canadian growth, especially for the start of 2022. A wave of restrictions in recent days, which may only be warming up, points to a rough repeat of the setback Canada’s economy saw in Q2 (when GDP dipped 3.2% during third wave shutdowns). In contrast to the U.S., Canadian growth came up a bit light of our expectations this past year—a year ago we looked for 5.0% growth (and at one point we called for 6.0%), while it’s more likely to be 4.5%. The three big drags on activity were virus restrictions, weak auto output on chip shortages, and the severe drought in Western Canada. There are zero guarantees that any of these will see a big improvement in 2022, but we expect a resilient 4.0% growth rate in the year ahead, followed by a further recovery of 3.5% in 2023. This will bring activity nearly back to “normal” by late-2023, but the road to recovery will no doubt be bumpy and face many curves. Even with a lighter snap-back than stateside, and somewhat milder inflation, the Bank of Canada has been at the leading edge of warning of tighter policy ahead. Armed with a refreshed inflation mandate, a torrid housing market, and a full recovery in employment, we expect the Bank to begin raising rates in April, presumably after some of the Omicron clouds have parted.

Doug Porter is chief economist and managing director, BMO Financial Group. His weekly Talking Points memo is published by Policy Online with permission from BMO.