Takahide Kiuchi's View - Insight into World Economic Trends :
The 2022 Global Economic Outlook - A Focus on Soaring Prices and Normalization of Monetary Policy -
Dec. 10, 2021
With the sudden advent of the new Omicron variant of Covid-19 in late November this year, the global economic outlook for next year 2022 is quickly becoming more and more uncertain. In addition, global price surges and the future of monetary policy normalization recently begun in the US and other leading countries—both of which are significantly affected by the consequences of this viral spread—could very well set the course for the global economy and financial markets in 2022.
How long will prices skyrocket?
While it varies from country to country, the surge in prices has become notable in many countries since around springtime this year. In Japan, the overall consumer price inflation rate has remained near zero compared to last year, but as a result of soaring crude oil prices and food prices overseas, Japan has seen a rise in electricity charges, gas prices, food prices, and other costs, and this is putting pressure on citizens’ lives. The price hikes seen in a wide range of areas are becoming a major headwind for the global economy, which is only just getting back on its feet after the Corona Shock.
Soaring inflation is a consequence of various overlapping factors, yet the underlying cause here would seem to be the major changes in individual consumer behavior in the wake of the Covid-19 pandemic. For example, individuals fearing the risk of infection have reduced their consumption of services involving face-to-face personal contact, such as dining out, travel, and culture and entertainment-related services. At the same time, people have shown a greater tendency toward stay-at-home consumption, having more meals at home, and spending more of their money on furniture, home appliances, household items, and online shopping. Broadly speaking, we have seen a shift from the consumption of services to that of goods.
In industries where demand has increased during the pandemic, production and supply have failed to keep up with that demand, and supply shortages have caused prices to rise. Expanded production in the manufacturing industry has rapidly increased demand for raw materials and electricity, andelectricity and has led prices to skyrocket in the commodity markets and in crude oil and other energy-related sectors. Furthermore, with concerns over the risk of infection remaining deeply rooted among workers, it is becoming more difficult to make sure there are enough drivers and to otherwise secure enough labor in logistics and distribution, and this difficulty is causing personnel costs to rise. That is driving up logistics costs, which are then being passed along onto product prices in many cases, including in energy-related fields.
The global economy is in a transition phase right now, marked by changes in individual consumer behavior resulting from the Covid-19 pandemic, and by a consequent shift toward new industrial structures. Soaring inflation is arguably one of the “birth pangs” that have temporarily arisen in the process.
Prompted by rising prices and wages, companies will conceivably seek to expand their production of goods and services that are now in higher demand, while workers will likely shift over to those fields, and we can expect that the supply shortages will gradually be eliminated. Further, the soaring commodity prices and the uptick in price and wage increase rate that we see now will slowly disappear, and our industrial structures and pricing systems will likely reach a new equilibrium point.
With the appearance of the Omicron variant, crude oil prices—which had been on a meteoric rise—temporarily plunged from their peak by around $20 per barrel. It is hoped that this will help to ease the risk of a global price surge going forward. I would like to think this means that soaring inflation will have rather run its course by around the spring of next year.
The global economy in the first half of 2022 will see slower growth
According to the global economic outlook published at the beginning of December by the OECD (Organisation for Economic Co-operation and Development), the global economic growth rate in 2021 was 5.6%, a significant rebound from the 3.4% contraction seen in 2020, and a relatively strong recovery of 4.5% growth is also projected for 2022.
In fact, while the global economy is expected to continue its recovery trend in 2022, it is also possible that this rebound will not be as strong as the OECD has predicted. In particular, the pace of growth in the first half of the year is projected to fall noticeably. The primary cause behind this is the resurgent risk of infection precipitated by the emergence of the Omicron variant, which could have more substantial adverse effects on economic activity.
The second such cause is the impact of the real estate slump in China. With no end in sight yet for the management crisis gripping the real estate mega-developer Evergrande Group, sluggish housing sales and falling housing prices are creating a serious headwind for the industry overall. As the Chinese economy is highly dependent on real estate, this real estate slump could quite possibly lead to economic stagnation in a broader sense.
Meanwhile, if China’s economy—which currently accounts for 18% of global GDP (IMF estimate)—were to see a significant drop in its pace of growth because of this real estate slump, there would be unavoidable deleterious consequences for the world economy as well.
The third underlying cause would be the negative effects of soaring inflation, which has gone on longer than anyone expected. According to the OECD’s analysis, household inflation over the next year in the US is expected to be slightly under 5%, whereas wages are projected to rise by a little under 3%. If we put these together, the forecast suggests that real wages will fall by 2% over the next year, and that soaring inflation will have been a major blow to personal consumption. The situation is probably similar in other countries too.
On the one hand, Japan’s real GDP was significantly down in the period from July to September 2021, showing a 3.6% contraction from the prior period (second preliminary figure). With the state of emergency having been lifted now, personal consumption has been recovering, and GDP is expected to follow a positive growth track starting in the period from October to December 2021.
However, there likely will not be any rebound in consumer activity that is strong enough to qualify as revenge consumption. Given the risk of infection, consumers will probably continue to be cautious in their behavior, and the uptick in prices may in a sense preclude the recovery of consumer confidence, as we have already seen. With consumer activity having brought about structural changes, spending on things like dining out and travel may not return to pre-pandemic levels, and this too could prove detrimental for a rebound in consumer behavior. Moreover, although exports had been bolstering the Japanese economy, they actually declined between July and September 2021 versus the prior period, because of the weaker growth of the Chinese economy. Going forward, this declining trend looks to continue for some time, and that will likely mean a slow recovery for Japan’s economy in 2022.
When will the FRB move to raise interest rates?
Against the backdrop of surging inflation, the world’s central banks began taking stronger action in 2021 toward normalizing monetary policy. In countries including Norway, New Zealand, South Korea, and Mexico, central banks began raising interest rates (policy interest rate hikes).
The FRB (US Federal Reserve Board), an institution whose policies have major repercussions for global financial markets, embarked on a so-called “tapering” program in November to gradually draw down its asset purchases, thus beginning down the road to normalization.
The last time the FRB moved to normalize monetary policy, it caused a “taper tantrum” that shook the financial markets merely by suggesting that it would begin tapering. Markets in emerging countries were thrown into turmoil by the flow of funds returning to the US, and the FRB drew harsh criticism for it.
With the FRB now heading towards tapering once again, there are no signs yet of anything similar happening this time. That is likely because the asset buyback program is no longer considered by the FRB or the markets to be as important a policy as it once was. Compared to interest rate policies that have a more direct effect on short-term policy interest rates, it is uncertain what policy effects will result from adjustments to the asset buyback amount through changes to long-term interest rates.
Any deleterious effects on global financial markets will likely be far more prominent this time not from the tapering itself, but from the rate hikes that are to follow. And such volatility in the financial markets will have an impact on the global economy as well.
The expectation in the financial markets is that the FRB will start raising interest rates from around mid-2022, and will subsequently carry out further rate hikes at an extremely gradual pace for a total 1.5% raise by the end of 2024. If—as I have already indicated—the inflation surge runs its course around spring of 2022, but the US economy sees a conspicuous slowdown in growth, there is a chance that the timing for starting these rate hikes could be pushed back even further. In that case, the FRB’s rate hikes would not have an unfavorable impact on the global economy and the financial markets in 2022, and the growth rate would likely recover in the second half of the year.
However, if prices continue to surge even longer while growing inflationary concerns cause long-term interest rates to rise significantly, and thereby lead to instability in the financial markets, the FRB will likely be forced to move up its timetable for the rate hikes at the expense of economic growth, and perhaps even to proceed with these hikes at a more rapid pace, all to ensure the stability of the markets. That would create a major headwind for the global economy, and the world could possibly even experience stagflation in which soaring prices and economic downturn go hand in hand. While this is still just a risk scenario, we probably ought to bear in mind that things could turn out this way.