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Economy in Brief

Viewpoints

As Good As It Gets?
by Andrew Cates  July 15, 2021

Growth forecasts for 2021 for most major economies have been revised up since the beginning of this year (see figure 1 below). A sharp increase in the Blue Chip GDP consensus for the US - from 4.4% in January to 6.6% in July - has been particularly striking. However, the upward revision in the UK – from 4.9% to 7.0% - also stands out. Impressive vaccination programmes and accommodative fiscal policy have been key hallmarks of both economies relative to many others. But unorthodox monetary policy and loose financial conditions have played a supporting role as well.

Figure 1: Consensus GDP forecasts for 2021 in the US, China, Japan and the Euro Area

But is this growth optimism justified? Maybe not! Notwithstanding a pattern of positive growth revisions so far this year, the latest Blue Chip survey of economic forecasters for July nevertheless revealed small downward revisions to the 2021 GDP consensus for the US and China. Incoming economic data from both countries have certainly surprised forecasters on the downside more frequently in recent weeks (see figure 2).

Figure 2: Citigroup Economic Surprise Indices for the US, China and the World

More fundamentally the pandemic-induced spending shift toward high-productivity goods sectors and away from low-productivity service sectors may now have run its course. Supply side congestion is also amplifying inflation tensions, particularly in the US, and potentially sapping purchasing power. The impulse to economic activity from loose monetary policy in the meantime is s also set to fade in the months ahead. Indeed our calculations at Haver Analytics suggest that credit impulses in the US, China, the Euro Area and the UK have already turned negative in the last few months (see figure 3 below). On the fiscal policy front the impulse to growth is also set to fade in the months ahead, particularly in the US (see figure 4).

Figure 3: Credit impulses for the US, China, the Euro Area and the UK have turned negative

Figure 4: Fiscal impulses are set to fade and then drag on growth in 2022
(negative data imply an impulse, positive data imply a drag)

This all matters of course from a growth perspective. But it may be of some significance for the inflation outlook too. This week's data showing that US CPI inflation jumped to 5.4% in June - its highest level for over thirteen years – was another bolt from the blue for economic forecasters. Forecasts for monthly US inflation prints have been too low now for the past several months, as evidenced by the recent upward trend in our US inflation surprise index (see figure 5 below). And this has understandably triggered some alarm that US monetary policy is presently too loose and could be tightened more quickly than investors anticipate in the period ahead.

But as Fed Chairman Powell seemed to iterate this week – and as financial markets appear to be discounting – these inflation alarm bells are not ringing that loudly, at least not yet. And that in turn can be traced to some of those aforementioned fundamental factors.

Figure 5: Cumulative inflation surprise indices for the US, Euro Area and UK

Source: Action Economics, Informa Global Markets, Haver Analytics

Inflation pressures, after all, are somewhat narrowly confined at present to only a few major economies, and the US in particular. Those pressures in the US moreover are somewhat narrowly confined to a few sub-components and specifically components that are closely related to the consumption of goods (e.g. used cars). That increase in goods consumption though is, in turn, related to: a) a pandemic-induced shifts toward goods consumption and away from services consumption; b) supply side congestion in some sectors (e.g. semiconductors) that have had ripple effects for other sectors (e.g. cars); c) super loose US fiscal policy and one-off transfer payments to households in particular which helped to spur additional spending on consumer durables and d) super- loose monetary policy which has driven house prices higher and further catalysed household goods demand. The evidence in support of this narrative (and its absence in other major economies) is illustrated in figures 6, 7 and 8 below.

Figure 6: US CPI inflation – goods (commodities) and services

Figure 7: US Core CPI inflation versus the deviation of retail sales volumes from trend

Figure 8: The deviation of retail sales volumes from trend in China, Japan and the Euro Area

The bottom line here is that lofty growth expectations are presently at risk on a number of fronts. These include a likely shift toward services spending in major economies and easing supply side congestion as the pandemic winds down combined with a fading stimulus from fiscal and monetary policy. Insofar as inflation pressures have been building in large part because (US) consumers have rotated toward buying goods where supply side pressures were most acute and because of a one-off income boost, there are good reasons to remain sanguine that inflation alarm bells will not ring more loudly in the period ahead.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

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