Vanguard Economic & Market Update for September 2021
Key points
A resurgence in COVID-19 cases and extended lockdowns have led us to lower our full-year growth forecast for Australia, with risks skewed to the downside.
The Reserve Bank of Australia (RBA) will delay further tapering of bond purchases until at least February 2022 due to increased uncertainty associated with the Delta outbreak.
The showdown in the U.S. Congress over the debt ceiling has raised the possibility that the United States could default on its debt, but such a scenario remains highly unlikely
The U.S. Federal Reserve is likely to begin tapering asset purchases this year, assuming the pace of economic recovery and jobs momentum continues.
Australia
COVID-19 lockdowns in New South Wales and Victoria have persisted longer than our downside scenario anticipated. This has led us to further lower our full-year growth forecast for Australia from a range of 4.5% to 5% to a range of 3.5% to 4%, with risks skewed to the downside.
We now assume a third-quarter contraction in gross domestic product (GDP) in a range of –2.5% to –3%, from our previous view of a contraction of –1.5% to –2%. We anticipate a rebound in growth to around 1.5% in the fourth quarter, assuming restrictions remain in place through October, the expected timeline for roughly 70% to 80% of the population to have been vaccinated.
The RBA left its cash rate intact at 0.10% at its September policy meeting. The bank also said it would slow purchases of government securities to a rate of AUD 4 billion per week, as previously announced, but would continue purchases at that pace until at least mid-February 2022. The new timetable was extended from mid-November 2021 to reflect “the delay in the economic recovery and the increased uncertainty associated with the Delta outbreak.”
The Consumer Price Index (CPI) rose by 0.8% in Australia in the quarter ended 30 June, and by 3.8% compared with a year earlier, the latter largely attributable to base effects. Vanguard expects that, given spare capacity in the economy, core CPI will undershoot the RBA's 2% target in 2021, ending the year around 1.6%.
COVID-19 restrictions could mean a temporarily rising unemployment rate in Australia. The August Labour Force survey reading showed a monthly fall in employment of 146,300, which included a drop in full-time employment of 68,000. The unemployment rate fell over the month from 4.6% to 4.5%, due to a fall in the participation rate from 66% to 65.2%. We expect the unemployment rate to peak around 5.2% in October before gradually falling to around 4.5% by the end of 2022.
United States
Vanguard has lowered its third-quarter and full-year growth forecasts for the United States amid signs of slower-than-expected growth, supply constraints and a COVID-19 resurgence. We foresee GDP growth coming in around 5.5% for the third quarter, lower than our previous view of 8.5%. Our forecast for full-year growth has been revised to around 6% from our previous expectation of around 7.5%. Under our revised forecasts, the United States would reach its pre-pandemic growth trend in the first quarter of 2022, rather than the fourth quarter of 2021.
Minutes of the U.S. Federal Open Market Committee's (FOMC's) July meeting suggest the Federal Reserve plans to start to reduce the pace of its asset purchases this year. Assuming a strong September jobs report and continued economic recovery, Vanguard anticipates that a tapering would likely be announced at the Fed's November meeting.
Vanguard is watching two important developments in Washington related to U.S. government funding. One is the authorisation of certain spending due to expire on 30 September, and the other is the need to raise or suspend the U.S. debt ceiling. Vanguard believes that the likelihood of a default on U.S. debt obligations is extremely low, but we're watching closely given the magnitude of potential consequences of such an event.
The inflation environment is likely to be more volatile in coming years than we've come to expect recently. In our base case, the core CPI will come in around or above 3% through the first quarter of 2022, settle back just below 2% for some time, and end 2022 above the Fed's target of 2%.
The labour market in the United States took a pause in July, with growth in job creation slowing to a seven-month low of 235,000. Vanguard believes the number belies the strength in the U.S. labour market. Threemonth average job growth stands at 750,000, and we anticipate average monthly job growth of around 700,000 for the rest of the year.
Euro area
Daily new cases of COVID-19 have fallen recently in previous hot spots including Spain and France, and hospitalisations appear to have peaked across the euro area. We maintain our view of full-year GDP growth of around 5%, which we expect to be supported by increased consumption in the third quarter. GDP grew by a seasonally adjusted 2.2% in the second quarter, compared with the first quarter, according to the most recent estimate. The gain reversed a first-quarter decline of 0.3%.
The European Central Bank (ECB) said in September that it would moderately slow the pace of asset purchases under the Pandemic Emergency Purchase Programme (PEPP) from the current €80 billion per month beginning in the fourth quarter. ECB President Christine Lagarde characterized the slowdown in purchases not as a “true taper”, but as a “recalibration of the PEPP for the next three months”. The change came alongside the ECB's upgrade to its outlooks for both GDP growth and inflation, in both cases moving toward Vanguard's views.
Headline inflation in the euro area is likely to have reached 3% in August, according to a flash estimate. The increase was partly driven by a rise in energy prices, although underlying price pressures also increased. Core inflation, which excludes volatile food and energy prices, was estimated at 1.6% compared with a year earlier, higher than the 0.7% reading for July.
We don't expect as large or as persistent an inflation overshoot in the euro area as in the United States, as accumulated household savings are lower in Europe and inflation expectations are well-anchored below 2%. Unemployment in the euro area fell to 7.6% in July from a revised 7.8% in June on a seasonally adjusted basis and from 8.4% in July 2020.
United Kingdom
Vanguard continues to expect GDP to grow by around 7% for all of 2021 in the United Kingdom, with activity unconstrained by significant COVID-19 restrictions for the first time since the start of the pandemic. GDP rebounded in the second quarter compared with the first, up by 4.8%. On a monthly basis, GDP grew by 0.1% in July, after a 1% gain in June.
The Bank of England (BOE) maintained the bank rate at 0.1% at its August Monetary Policy Committee (MPC) meeting, but delivered a hawkish tone, leading Vanguard to bring forward its projection for rate lift-off. We now expect the BOE to begin to raise the bank rate in the second half of 2022, compared with our previous projection of the first half of 2023. The MPC voted to leave the target for the bank's stock of asset purchases at £895 billion, including £875 billion of government bonds and £20 billion of investment grade corporate bonds. However, it lowered its threshold interest rate at which the balance sheet run-off could start from 1.5% to 0.5%.
Headline inflation reached 3.2% in August in the United Kingdom compared with a year earlier, following a 2% year-on-year rise in July. The U.K. Office for National Statistics noted that the 1.2-percentage-point onemonth increase was the largest in the history of the series dating to 1997; it also said such a rise was likely to be temporary.
With the continued run-up in global industrial prices, combined with the coming reversal of a value-added-tax cut this month and a stronger consumer demand impulse, we expect headline and core inflation to peak around 4% and 3.5%, respectively, on yearon- year bases in the fourth quarter. We then expect both core and headline inflation to ease over 2022 as these temporary factors unwind, both ending the year just above 2%.
China
Risks to economic growth remain tilted to the downside in China, though the most recent outbreak of the COVID-19 Delta variant appears to be under control. Given the highly contagious nature of the Delta variant and the relatively low efficacy of China's vaccine, the risk of further outbreaks and lockdowns remains elevated. We continue to anticipate full-year economic growth just below 8.5%.
Purchasing managers indexes for August were mostly weaker, with the services index falling to a level that indicates contraction and the manufacturing index sitting just above that level. But we anticipate stronger readings in September. August export data were stronger than expected, helped by a temporary diversion of orders from Southeast Asian nations dealing with COVID-19, and with resilient demand from developed markets for tech and capital goods.
Vanguard continues to anticipate a macroeconomic policy pivot toward a modestly easy stance in China—compared with tightening in the first half of the year— given an uneven growth backdrop. We expect policy to support sectors in need, such as small and medium-size enterprises. But we foresee ongoing regulation for sectors where financial stability is a consideration, such as the property market.
We expect local government bond issuance and infrastructure investment to pick up over the rest of the year, with signs of a rebound in the former emerging in August. We expect credit growth to pick up modestly in the fourth quarter as liquidity released by the People's Bank of China's recent 50-basis-point reserve ratio requirement cut supports corporate and local government bond issuance.
Growth in consumer prices continued to slow in China, with the CPI rising 0.8% yearon- year in August, a third straight month of slowing gains. Compared with a month earlier, consumer prices rose by just 0.1%. We expect full-year headline inflation in a range of 1% to 1.5%, well below China's 3% target. Producer prices, meanwhile, surprised to the upside, rising 9.5% on a year-on-year basis and 0.7% compared with July, largely reflecting stronger demand for commodities amid tight supply.
Emerging markets
COVID-19 continued to tell a divergent story in emerging markets in August. Emerging Asia, which we had anticipated at the start of the year to be the strongest emerging region for growth, has been beset by low vaccination rates and—given its many zero-COVID lockdown approaches—a low rate of infection-acquired immunity.
Latin America, meanwhile, which had been hit hard by the virus around midyear, has continued to see case counts fall in recent weeks. We're watching for the degree to which some of the world's more developed emerging markets, such as South Korea, might be able to use their relatively higher vaccination rates to move away from zero-COVID lockdown approaches that can weigh on growth.
A case of classic emerging market central bank behaviour is afoot, with Peru and South Korea initiating their first hikes of the post-COVID-19 cycle in August, joining Chile, Hungary, Russia, Mexico, Brazil, and Turkey, which had already started their hiking cycles. The Bank of Russia's rate hike in September, from 6.5% to 6.75%, was its fifth straight, and may not be its last.
Although concerns about inflation are typically behind rate hikes to some extent, hikes may also be a function of central banks' desire to protect local currencies by getting ahead of developed-market hiking cycles. Banco de Mexico, Mexico's central bank, raised the target for its overnight interbank rate by 25 basis points in August to 4.5%, just seven weeks after a surprise hike to 4.25%.
Rising agricultural commodity prices are driving inflation in emerging markets. Food and beverage prices rose 1.39% in August compared with July in Brazil, accounting for a third of an overall 0.87% onemonth inflation rate. Inflation was 9.7% compared with August 2020, higher than the 8.9% year-on-year inflation in July. We're watching inflation in Southeast Asia for signs that supply-chain issues may linger for longer than we had expected, which could feed inflation in developed markets.