Regional Cyclical Outlook for 2022: Post‑Peak Growth and Shifting Policy
Much of the global economy has transitioned quickly from an early-cycle recovery to a mid-cycle expansion that now appears to be rapidly progressing toward late-cycle dynamics. Global real GDP growth – and fiscal policy support – likely peaked in 2021. In our base case, we forecast global inflation to peak by the first quarter of 2022, driven in part by monetary policy pivoting toward normalization in most regions. Overall, as we explained in our Secular Outlook, “Age of Transformation,” we believe what lies ahead is a more volatile and uncertain growth and inflation environment with paths that vary across regions and sectors.
Here we share our 2022 outlook for growth, inflation, and policy for major economic regions. For detailed insights into economic trends in 2022, along with investment implications, please read our Cyclical Outlook, “Investing in a Fast-Moving Cycle.”
U.S.: Rebalancing and restocking
We believe the U.S. will undergo three transitions in 2022, producing slower but above-trend growth and slower but above-target inflation. First, policy support should give way to organic growth as fiscal stimulus and central bank policy will tend to be less supportive in 2022. Second, pandemic-related goods spending should give way to a further services recovery – notwithstanding the continuing disruption in services activity in the first quarter driven by the omicron variant of COVID-19. Third, final domestic demand growth should give way to inventory restocking. Bottlenecks constrained production in 2021, which – paired with strong goods demand – depleted inventories. In 2022, slowing final domestic demand growth coupled with easing supply constraints should support restocking. Overall, we look for real U.S. growth to slow to a 3.5%–4% (Q4/Q4) range in 2022.
Rebalancing and restocking should ultimately help inflation moderate back toward the U.S. Federal Reserve’s target in late 2022. However, we expect inflation to remain well above target until then, with core CPI (U.S. Consumer Price Index) peaking around 6% in the first quarter. Given this inflation backdrop, we look for the Fed to start hiking rates in March 2022 and to begin shrinking its balance sheet around midyear.
Nevertheless, we see several risks to this “Goldilocks” outlook for above-trend growth, moderating inflation, and gradual monetary policy tightening. First, the current, significantly above-target reported inflation risks increasing long-term inflation expectations, which in turn would likely prompt a sharper response from the Fed. Second, the speed with which labor supply recovers and the labor market tightens is a risk. Relative to other developed market economies, the U.S. labor market appears tight, and the extent to which productivity gains can offset higher wages is uncertain. Third, while predicting the path of the virus is difficult, the U.S. has historically experienced higher pandemic-related anxiety than other developed economies, highlighting the risk to economic activity from additional virus cases even in the absence of additional government restrictions. Finally, the omicron variant also poses an upside risk to inflation, as any further disruption to production and shipping would come at a time when U.S. inventories for many retail goods still remain near record lows.
Euro area: Robust recovery to continue beyond winter wobble
The Euro area is likely to continue to grow at an above-trend pace of around 4% overall in 2022, though growth is likely to be subdued in the early part of the year given lingering supply bottlenecks, higher energy prices, and virus-related social restrictions. A fairly brisk acceleration is then likely in the spring, when economic normalization looks set to continue, with the economy resuming its progress toward closing the gap with its pre-crisis trend. Risks to the outlook look fairly balanced, with the presence of excess savings and the potential for higher pent-up demand being a key upside risk, and with virus-related issues and supply bottlenecks being key downside risks.
Euro area inflation looks set to be above target, with headline inflation averaging around 3% overall in 2022. Sequentially, however, the trend for inflation looks set to be sharply downward, with inflation falling from 5% year-over-year (y/y) at the end of 2021 to around 1.5% y/y by the end of 2022. Contributing to the slowdown will be significant negative base effects in energy prices, as well as fading boosts from supply bottlenecks and reopening effects on core prices. Subdued wage growth, a history of inflation undershoots, and a lesser fiscal response to the crisis help explain why Euro area inflation has been generally lower than in the U.K. and the U.S.
The moderate inflation outlook suggests that the European Central Bank (ECB) will remain patient in terms of exiting from stimulus, keeping the policy rate at −0.50% and continuing to make net asset purchases – albeit at a progressively reduced pace – through the cyclical horizon. As for fiscal policy, some consolidation is expected in 2022, though mostly due to a roll-off of emergency measures rather than active fiscal tightening.
U.K.: Fiscal and monetary policy easing off the accelerator
The U.K. has remained a growth laggard since the start of the pandemic, with quarterly GDP still below its pre-pandemic level – slightly weaker than in Europe, and much weaker than in the U.S. Exports have been particularly weak, likely in part related to Brexit. Looking ahead, we expect GDP to continue to normalize in 2022, up perhaps 4%–5%, as resilient private sector demand more than offsets a drag from less supportive monetary and fiscal policies. Sequentially, we expect growth to reaccelerate in early spring, following a weak start to the year when lingering supply bottlenecks and a modest drag from renewed virus concerns will likely weigh on activity.
As in much of the developed world, U.K. inflation has surprised to the upside. Energy prices have risen sharply, while supply bottlenecks, labor shortages, and reopening pressures have increased core inflation. We expect headline inflation to peak around 6%–7% in late spring – later than in the rest of Europe because of planned increases in regulated energy prices – before falling sharply as supply bottlenecks ease and reopening effects fade, with core inflation ending 2022 just above the Bank of England’s (BOE’s) 2% target. Inflation risks are two-sided: A large fiscal and monetary overhang may lead to a longer price level adjustment, while a quicker normalization in supply, in particular in labor participation, could lead to a sharper fall in inflation.
Policy is set to turn less supportive. The BOE raised its policy rate in late 2021, and in our baseline view, we expect another two to three hikes in 2022. Uncertainty is high, but as long as medium-term inflation expectations remain anchored, we expect the BOE to proceed gradually, easing off the accelerator rather than moving into a contractionary stance. Fiscal policy, meanwhile, will mechanically remain contractionary in 2022 as pandemic-related emergency measures continue to roll off. That said, we expect the government to announce more stimulus closer to the next general election.
Canada: Slower potential growth to constrain rates
Preliminary data suggest Canadian real GDP grew 4.8% (annualized) in 2021 – more or less in line with prior forecasts. However, the Canadian labor market recovered more quickly. Indeed, the surprisingly sluggish productivity growth, along with supply bottlenecks in product markets and surging inflation, prompted the Bank of Canada (BOC) to reassess its estimates for potential growth and bring forward the expected timing of rate hikes. As a result of this and our forecast that Canadian real GDP growth will remain solidly above trend in 2022, in a range of 3.5%–4%, we expect the BOC to begin hiking rates in March and to hike four times in 2022.
Nevertheless, we expect the ultimate path of the Canadian policy rate to be shallower than what the market is currently pricing for several reasons. First, while the lower post-pandemic productivity growth implies a smaller output gap, it also implies lower trend growth and a lower real neutral rate of interest, which will ultimately tend to limit how high the policy rate can rise. Second, Canada’s economy is relatively interest rate sensitive as a result of higher household leverage and the composition of the residential mortgage market, which relies heavily on floating rate mortgage lending. Third, we doubt that the BOC will be able to hike much above the U.S. fed funds rate without currency appreciation that could in turn impede growth. Finally, similar to our U.S. forecast, we expect inflation in Canada to moderate throughout 2022 and early 2023, reducing the urgency for additional rate hikes.
Also similar to the U.S., the outbreak of the omicron variant of COVID-19 raises important risks to our baseline forecast. However, for now, we expect a moderation in first-quarter growth to be offset quickly by a reacceleration in the second quarter and beyond.
China: More efforts to stabilize growth
We anticipate a difficult year for China, in contrast to the continued recovery in developed markets. In our base case, we expect China’s GDP growth to moderate to about 5% y/y in 2022. Growth has been hindered by energy market constraints and the weakening property market. The energy supply bottleneck likely will ease after the first quarter, helping ease inflation, but our outlook for the housing market remains shadowed. Exports have outperformed in the past two years but are expected to moderate in coming quarters due to high base levels and softening external demand for manufactured goods. Meanwhile, the lingering pandemic is impeding the recovery in the domestic services sector and in household consumption, and the implementation cost of China’s “zero-COVID” strategy – which the country likely will follow through 2022 – is getting increasingly higher, as the new virus variants are far more transmissible.
Policy turned more supportive starting in the fourth quarter of 2021, with December’s Central Economic Work Conference sending a strong signal for further policy easing in 2022. In our view, much of China’s recent economic slowdown is policy-driven as the government strives to push forward its long-term agenda, including decarbonization, deleveraging, and common prosperity. However, the coordination issue among different bureaus and local governments has led to overtightening, amplifying the short-term pain brought by reforms. While the reforms are unlikely to reverse course, we expect near-term policy will be focused on correcting the overtightening, facilitated by moderate macro supports.
Fiscal policy will likely become more accommodative, with front-loaded local government special bond issuance, accelerating government spending, and tax cuts. This should provide some support to infrastructure investment and household consumption. But we believe the overall fiscal impulse will be modest, as on-budget stimulus tends to be undermined by weaker off-budget financing: For example, land sale revenue and local government financing vehicles (LGFVs) likely will remain constrained by the government’s efforts to deleverage property developers and local governments.
China’s monetary stance has become dovish. The People’s Bank of China (PBOC) cut the required reserve ratio (RRR) by 50 basis points (bps) in December 2021, and lowered the policy loan prime rate (LPR) by 10 bps in January 2022, following a 5 bp cut in December. The continued deterioration in growth momentum may prompt it to do more, especially in the first quarter to early second quarter if the current COVID outbreak spreads further or the housing market fails to stabilize in the near term. Nevertheless, the impact of rate cuts could be limited, as credit growth remains the most effective monetary instrument, and it is currently constrained by weak credit demand. We expect credit growth to pick up moderately in 2022 as the authority eases credit supply and further normalizes funding to the property market.
For detailed views on China’s economy and policy in 2022, please read our Viewpoint, “Asia Market Outlook 2022.”
Japan: Private consumption driving growth
We expect Japan’s GDP to return to pre-pandemic levels by the end of 2022, with growth predominantly driven by private consumption. Vaccination rates picked up in the third quarter of 2021, and now vaccination levels are at or above the average of developed nations. We believe this improved vaccine situation will contribute to domestic consumption in 2022, provided COVID hospitalizations are limited and government restrictions remain moderate. The large fiscal package announced in November 2021 includes cash handouts to individuals, subsidies for small and medium-size businesses (SMEs), and an increase in wages for child care workers and nurses, which should also contribute positively toward consumption.
With regard to external factors, supply chain constraints weighed on Japan’s net exports in 2021, but we expect a bounce in the second half of 2022. We also see potential upside from an increase in inbound tourism.
Inflation in 2021 was muted, due mainly to the rebasing of Japan’s CPI basket along with government policies to slash cellphone carrier charges. Looking ahead, Japan could face some inflationary pressure from a weaker yen and higher commodity prices, which could push CPI above 1% by mid-2022; however, given our base case for limited wage growth, cost-push inflation alone is unlikely to be sustainable. We also do not expect inflation to lead to significant monetary policy action in Japan in 2022.
Emerging markets: Recovery slowing amid inflationary and idiosyncratic risks
The macro outlook for emerging markets (EM) in 2022 is mixed, with growth slowing as the recovery matures and with inflation above target – and still rising. Across countries, there is a sharp variation in the pace of the recovery given COVID dynamics, commodity reliance, susceptibility to global shocks, and country-specific idiosyncratic events. These may be accentuated in 2022 if there is a sharper divergence in the U.S. recovery versus Europe and China. We forecast GDP-weighted growth across four of the major EM countries – Brazil, Russia, India, and Mexico (BRIM) – to slow to 4.1% y/y in 2022 from 7.5% y/y in 2021. Economic activity could reach pre-pandemic levels by the first half of 2022.
Inflation remains a key factor for the EM cyclical outlook, with both headline and core data well above target. While there are some signs of a moderation ahead given recent production trends and slowing growth momentum, we forecast 2022 BRIM headline inflation at 6.2% y/y, unchanged overall from 6.2% y/y in 2021. While there are risks to the upside, we expect headline CPI to moderate toward central bank targets toward the end of the year.
EM monetary policy is likely to err on the hawkish side in 2022 given the deterioration in EM inflationary dynamics and the shift by developed market (DM) central banks toward tightening. Most EM central banks already tightened policy in 2021, and we expect they will continue doing so, leaving EM real rates substantially positive by the end of 2022. Low-yielding EMs will likely lead the way, potentially driving the overall real rate differential between DM and EM to the widest levels seen since the global financial crisis.
We also expect the EM fiscal impulse to be largely contractionary in 2022. Most COVID-related support will be withdrawn and the large fiscal deficits of 2020 and 2021 reined in to help create fiscal space and stabilize higher post-COVID debt ratios. Governments have relied heavily on domestic borrowing to fund budget deficits during the pandemic, a trend we expect to decline in 2022.
Overall, EM external balances may widen slightly in 2022, but in our view this remains supported by generally stable capital accounts, flexible currency regimes, and the IMF SDR (International Monetary Fund Special Drawing Rights) allocations granted in 2021 that shored up FX reserves particularly in many vulnerable EMs. The EM ratings cycle has stabilized since the downgrades that followed the onset of the pandemic, and we see low risk of further EM sovereign downgrades over the cyclical horizon.
For detailed insights into economic trends in 2022, along with investment implications, please read our Cyclical Outlook, “Investing in a Fast-Moving Cycle.”