The second quarter of 2021 should see peak stimulus and the fastest rates of growth of GDP, turnover and profits as economies open-up from lockdowns. The main advanced countries have all responded to the pandemic measures with large programmes of money creation and bond buying by their central banks. This has been supported by larger expansions in the state budget deficits as they spend more to prop activity and incomes and live with lower tax revenues. Most countries have offered some kind of enhanced income support for people not able to go to work or open their businesses.
Over the second half of this year it seems likely the main central banks will slow their money creation and announce timetables to end state bond purchases. The Bank of England has announced a taper to purchases for the rest of this year – and implies there will be no quantitative easing from January 2022. The Bank of Canada has announced a taper in asset purchases. The European Central Bank may end its special programme in March 2022. Even the Fed is now talking about talks to taper its huge purchases of state bonds and mortgage securities.
Meanwhile, in the emerging market world Russia and Brazil have started to raise interest rates and India is experiencing inflation pressures to which its central bank may need to respond. Last week in Eastern Europe, Czechia and Hungary raised interest rates to head off inflation. The countries with very rapid inflation such as Argentina and Venezuela already have very high interest rates, and Turkey has had to accept a large hike to 19%, as its inflation rate rises too far. China has tightened its monetary policy this year, seeing a rash of substantial price rises in the raw materials and fuel it needs for the country’s manufacturing base.
Government finances recover
Barring a major resurgence of Covid-19 and widespread new lockdowns, budget deficits should rapidly fall this year as the recovery unfolds. Recent bad news in the form of more new cases and higher death rates from the virus have recently come from Colombia and Peru, not from the large advanced economies. Asia too has had a flurry of new cases.
In the advanced economies, tax revenues will rise as more activity rings the tills. Special measures of support for individuals and businesses will be rolled back as more normal working is resumed. Many governments, and particularly their Treasuries and central banks, will want to move their finances onto a more stable footing.
The US, the world’s largest economy, is an outlier in all of this. President Biden and his Treasury Secretary Janet Yellen want to run the economy hot to try to get more people into jobs – and to trigger a decent rise in pay for the lower paid at the same time. They are still trying to sell two substantial reflationary packages to Congress, the infrastructure programme and the American Families programme. There is likely to be a fiscal boost passed by Congress one way or another.
The government is also keen that the Federal Reserve does not withdraw its stimulus early and seems to have some influence with the central bank’s chairman Jerome Powell. This means that if inflation takes off and settles in at higher levels anywhere in the advanced world, it is likely to be in the US. Were this to happen then at some point the Fed would need to rein things in with rate rises as well as terminating bond buying.
There remain policy risks on both sides of the reflation/inflation argument. Premature withdrawal of fiscal and monetary stimulus could slow or abort the recovery, especially if Covid-19 is persistent and governments still impede social contacts. North America and Europe will soon have good vaccine protections, but we are many months away from this being achieved in the rest of the world. The US running too hot for too long could trigger an inflation where wages responded to the first round of commodity and goods price rises, spreading across the economy and embedding it in services. This would then need a larger response from the Fed to squeeze it back out of the system, with costs on GDP and company turnovers.
There seems little likelihood of runaway inflation in Japan, and not much in Europe. The deflationary forces of a falling and ageing population and entrenched savings habits make it unlikely. In the US on the other hand there remains a risk that the President succeeds with more fiscal stimulus, which helps sustain too fast an inflation rate. For now, the Fed still has the confidence of the market, and is making moves towards a more cautious approach. This bull market rests on it continuing to be in control of the narrative and events.
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