From Hot Vax Summer to Winter of Discontent—Stagflation-Lite Could Rock the Global Recovery

Stagflation isn’t quite the word. But for a world economy still trying to find its post-pandemic footing, the combination of lower growth and higher inflation evident in the latest readings from Bloomberg Economics’ nowcasts still isn’t good news.

Across the U.S., Europe and Asia, the nowcasts are flagging a slowdown in the recovery, with activity still some way short of the pre-pandemic trend. More troubling, in many major economies, inflation looks set to stay stubbornly above central banks targets.

In the U.S., after a delta-dampened third quarter, the latest nowcast readings are signaling lackluster performance in the fourth. Compounding the difficulties, inflation is set to stay lodged at a high level.

In China, under the accumulated weight of the Evergrande default, power shortages, and delta risks, growth is slumping into 2022. The early signs from the nowcast point to a fourth quarter expansion of just 4.3% year on year — a long way below the pre-Covid trend of 6%.

For the U.S. — and other advanced economies in a similar position — the blow to supply that’s taking the edge off growth whilst pushing inflation higher is an unwelcome combination that leaves central banks with no easy answers.

“A hot vax summer risks drifting into a winter of discontent” said Bloomberg economists Bjorn Van Roye and Tom Orlik. “With millions still out of work and elevated inflation, central banks are facing stagflation-lite.”

Mind the Gap

With recoveries flagging, GDP in most major economies is stuck below the pre-virus trend

From U.S. retail sales to China factory output, Bloomberg Economics’ nowcasts unite hundreds of data points to provide a high frequency read on the pace of growth and level of inflation across major economies ahead of the official data.

The latest readout for most major economies shows output poised to end the year still some distance short of the pre-Covid trend and — in some cases — moving in the wrong direction.

In normal times, that slack in the economy would mean inflation remains subdued. In the upside-down world of the Covid recovery, that’s not the case. Supply shortages, port congestion, and rising energy prices mean that even as output remains below potential, inflation in many countries is above central banks’ targets.

In the U.S., inflation is poised to end the year above 4% — more than double the Fed’s 2% objective. In the U.K. and euro area, the nowcasts point to fourth quarter CPI readings above 3%. The picture in China looks a little different. Factory gate price gains are sky high. So far, though, consumers haven’t suffered a sticker shock in the shops.


Inflation in the U.S. and Europe is set to stay stubbornly above target

For the world’s biggest central banks, a recovery losing momentum and inflation elevated means a complicated situation. Withdrawing stimulus to tame inflation would add another drag to the recovery when millions are still out of work. Supporting growth by keeping stimulus in place risks sending prices onto an upward spiral.

So far, the Federal Reserve and the European Central Bank are attempting a balancing act — signaling heightened vigilance on inflation without taking premature steps to tighten. The Bank of England, meanwhile, has a more hawkish tilt, flagging the possibility of a rate hike by year end. If price gains stay high, the Fed and ECB will face the same tough decision.

Cut, Hike, Hold

Bloomberg forecasts show central bank policy to end-2021 on diverging paths

Note: Mapped data show expected rate moves for distinct central banks. Sources: Bloomberg Economics and ECFC survey numbers for Czech Republic, Poland and Switzerland

In China, the central bank faces a different trade off — between supporting growth with easier policy and tamping down risks of a credit bubble with tighter. The latest signs suggest it is growth that will be the priority. Bloomberg Economics’ Chief Asia Economist Chang Shu expects a cut in the reserve requirement ratio — freeing up funds for banks to lend — before year end.

In other emerging markets, central banks don’t have that luxury. Brazil, Mexico and Russia have already embarked on their tightening cycles and have further to go. In Turkey, acting on instructions from President Erdogan, the central bank is attempting to defy economic logic with a cut despite high inflation. The falling lira shows the price of politically motivated monetary policy.

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