The Covid-19 crisis is still generating lively discussions on the future of globalisation of trade and finances, and global value chains. The share of foreign value added embedded in the exports of a country or region[1] is a good indicator of the level of involvement in global value chains. This share increased rapidly from the early 1990s until the global financial crisis of 2008, under the effect of trade liberalisation (cuts in tariffs and proliferation of free trade agreements) and falling transport costs. This increase was particularly significant in Asia, the emergence of China as the factory of the world leading to the imports of more intermediary goods mainly from Europe and North America
In his testimony to a commission of the US Senate, Jerome Powell has acknowledged that inflation is less transitory than considered hitherto, adding that, as a consequence, a faster tapering seems warranted. Despite this hawkish tone, the reaction of US Treasuries was muted. This may, amongst other things, reflect concern about how the pandemic might evolve. The new Omicron variant undeniably represents an uncertainty shock for households and companies. It comes on top of a negative supply shock that is already a clear headwind to demand. It clearly makes the task of central banks more complicated than ever when deciding how much of a monetary headwind they can create.
The global manufacturing PMI has been stable since the month of August although over the same period, the data have weakened in the US and the Eurozone, whilst staying well above the global level. Focusing on November, there was a significant improvement in France and Italy and even more so in Australia. The recent upward trend continues in Japan where the PMI is now solidly above the 50 level. The Czech Republic, South Africa and India saw particularly strong increases.
Our Pulse is clearly pointing to bad weather, as the blue area of the spider chart – the economic situation in the past three months – is clearly shrinking compared to the situation in the preceding three months – the area within the dashed line. The deterioration is noticeable in all sectors, with the exception of the construction industry. Ifo reported that the business climate in the manufacturing sector worsened in November for the fifth consecutive month. Industrial activity is dampened by supply bottlenecks and rising input prices. The improvement in expectations, in particular in the car industry, could signal that the shortages of parts in this sector are diminishing.
The first indications for Q4 2021 suggest that the main confidence indicators are holding at high levels, especially business sentiment. The improvement in the French labour market observed over the past several months also seems to be continuing. With Q3 GDP growth recently confirmed at 3% q/q, France should have no trouble reaching our full-year 2021 forecast of 6.7%. Even so, our Pulse seems to suggest that growth is slowing, held back by several headwinds. The first is the lag between order books and the turnaround time necessary for companies to meet demand. Order books have been full for several months, but supply disruptions are accumulating.
So far, Egypt’s economy has weathered the Covid-19 crisis without any significant worsening of its main macroeconomic indicators. GDP growth has remained positive, and the country's budget and external balances are relatively stable. The macroeconomic stabilisation achieved in previous years and external financial support are the main reasons behind these positive performances. In the short term, the outlook is mixed. The rebound in inflation, if it were to persist, could trigger a cycle of monetary tightening, with negative consequences for public finances. In addition, Egypt's external vulnerability remains significant given structural current account deficits and dependence on portfolio investment flows
The ECB insists on the need for patience before considering a policy tightening, despite current elevated levels of inflation. It believes that inflation will decline next year and that a wage-price spiral is unlikely to develop. Moreover, inflation expectations remain well anchored. Demand in the euro area is suffering from the headwind created by the jump in energy prices. Reacting to this type of inflation by tightening monetary policy would create the risk of reducing demand even more. To avoid such an outcome, it makes sense for the central bank to wait for more information to arrive, thereby adopting a risk management approach of monetary policy
Although there was no lack of effort from the British government in dealing with the coronavirus pandemic (20 points of GDP was directly transferred to the economy to tackle the health crisis, twice the European average), it was also one of the first to have decreed the end of “whatever it takes”. In October, the main employment support measures – the Coronavirus Job Retention Scheme and the Self-Employed Income Support Scheme – came to an end.
Companies in the euro area report record-high levels of labour shortages. These are partly cyclical in nature but structural factors also play a role. Last year’s annual investment survey of the European Investment Bank shows that the availability of staff with the right skills is the second most important factor weighing on long-term investment decisions in the EU. Structural labour shortages can weigh on potential GDP growth through its impact on capital formation, innovation and productivity. Economic and, in particular, education policy including vocational training and lifelong learning schemes will have to make sure that, going forward, the available skills, both in quantity and quality, fit the evolving needs.
Our monthly Pulse highlights the cyclical deterioration of the Chinese economy in August-October 2021 compared to the previous 3-month period. While the situation in the industrial sector improved in October after a sharp slowdown in September, the correction in the real estate sector has continued. Industrial production growth picked up slightly in October (+3.5% y/y in real terms, compared to 3.1% in September and 5.3% in August). In fact, the measures introduced by the authorities rapidly eased energy constraints last month.
According to our Pulse, the Eurozone’s cyclical situation has deteriorated over the past three months (the blue area is smaller than the area within the dotted lines). Hard data have dropped sharply but the decline in business climate surveys has been much milder. This difference is due to statistical distortions. For retail sales and production, the sharp decline in growth rates in year-on-year terms since May reflects a normalisation after the previous 3-month average was inflated by very favourable base effects in March and April.
After two solid quarters, Italian GDP growth is expected to slow in Q4 2021. Real GDP rose 2.7% q/q in Q2 2021 and 2.6% q/q in Q3. Yet there was an encouraging catching-up movement through the fall, which led the European Commission to revise strongly upwards its 2021 growth forecast, to 6.2%, from its previous outlook of 4.2% last spring. While a new epidemic wave could weigh on activity in the coming weeks, Italy is currently facing a level of contamination much lower than most other European countries.
Like other economies, Spain is currently facing several headwinds, including labour shortages, supply-chain problems and inflation. The country is now also facing the risk of another upsurge in the pandemic. In mid-November, the number of Covid-19 cases was still holding at a very moderate level, but it now seems to be ticking upward, a movement that is bound to accelerate with the approach of winter. Even so, Spain benefits from a high vaccine coverage ratio (more than 80% of the population is fully covered by the vaccine), meaning that the country can look forward to a less perilous winter than last year.
In the euro area, business surveys report record-high staff shortages. They represent a headwind to growth and raise the possibility of faster wage growth and a pick-up in inflation. Thus far, growth of negotiated wages has been subdued but, given its historical relationship with labour market bottlenecks, an acceleration seems likely. Despite the difficulties of companies in filling vacancies, labour market slack has remained above pre-pandemic levels. This situation should improve in the coming months but whether this eases labour market tensions depends on companies’ hiring intentions. Based on recent surveys, these should remain elevated.
The “transitory” surge in inflation is proving to be long lasting. In October, US inflation rose to 6.2% year-on-year, the highest level in 31 years. As in previous months, the main explanation is a ballooning energy bill (which accounts for 30% of this figure), but the acceleration in prices is spreading throughout the US economy. It can be seen in the cost of shelter, which is already up 3.5% year-on-year, and is surely bound to accelerate.
Manufacturing in Poland, as in the other central European countries, has been hit by increasingly severe shortages of inputs. Numerous components are in short supply, from semi-conductors to plastic parts. As a result, automobile production is down 15% from the high of year-end 2020, while electrical equipment is down 8% compared to the May 2021 peak. In both cases, production declined even though order books are relatively strong. Moreover, they have had a direct impact on the current account balance, which suddenly dropped from an average monthly surplus of EUR 500 m in H1 2021 to a deficit of about EUR 1.5 bn a month starting in July
The global manufacturing PMI was up slightly in October despite a weakening in the US and a small decline in the eurozone. There was a noticeable decline in France whereas Italy moved higher. Japan also saw an improvement. The levels in the advanced economies remain very high whereas in the emerging countries the picture is more mixed. Worth noting is the improvement in India and the jump in Indonesia and Vietnam.
The German economy further recovered in the third quarter, as GDP strengthened by 1.8% from the preceding quarter. Growth is mainly driven by higher consumer spending related to improved labour market conditions and a further relaxation of sanitary measures. However, our Pulse chart indicates that this favourable environment is unlikely to last: the situation in the three months to October (blue area) worsened compared to the situation in the preceding three-month period (area within the broken line).
The initial estimate of French growth in Q3 2021 surprised on the upside, with a rebound in GDP of 3% q/q, well ahead of our forecast (2.2%) as well as those of Banque de France (2.3%) and INSEE (2.7%). Furthermore, Q2 growth has been revised upwards by 0.2 points to 1.3%. One quarter ahead of schedule, France’s GDP is therefore almost back to its pre-crisis level of Q4 2019. Besides, the growth carry-over reaches 6.6%. Hence, on average over 2021, growth will be much stronger than expected (government forecast of 6.25% and our forecast of 6.3%).
The European Commission has relaunched a comprehensive review of the economic governance framework of the European Union. This initiative is necessary considering the impact of the Covid-19 pandemic on public finances as well as the investment needs in the context of the green and digital transformation. The review process comes with several challenges: an agenda which is particularly broad, the inclusive nature of the debate, involving many stakeholders and, as far as fiscal governance is concerned, the necessity for EU member states to strike a balance between committing to policy discipline whilst keeping national fiscal policy leeway
Chinese real GDP growth slowed to 4.9% year-on-year (y/y) in Q3 2021 from 7.9% in Q2 2021. In the services sector, growth slowed sharply in August (+4.8% y/y), due notably to the reintroduction of lockdown measures to counter a new surge in Covid-19 cases. Although services growth rebounded in September (+5.2%), it is still sluggish. Tighter regulations in a number of segments, including online services, tutoring and video gaming, have constrained activity. The services sector has also been hit by the downturn in the real estate market due to a severe tightening of prudential regulations and credit conditions in the sector. In Q3 2021, house sales contracted while property developers have encountered increasing financing and cash-flow problems
Did the UK government lower its guard too quickly? Since early July, it has lifted nearly all of the sanitary barriers to counter the Covid-19 pandemic. London no longer requires masks to be worn in public spaces, even indoors, nor the presentation of a “health pass”. These measures are left to the discretion of each individual. As a result, the “freest country in Europe”, according to UK minister David Frost, is also the one that reported the highest number of new cases in fall 2021: nearly 45,000 new cases a day. This is ten times more than in France, while the two countries have comparable populations and vaccination rates (67% altogether).
Although the significant increase in inflation in most advanced economies is expected to be transitory, it is necessary to focus on the potential consequences of inflation staying temporarily high for longer. Companies that hitherto have been reluctant to raise prices might do so after all, higher inflation could weigh on spending but also cause wage demands to grow, inflation expectations could drift higher, the market sensitivity to growth and inflation surprises would increase and there could be fears about a change in the reaction function of the central bank. In the coming months, investors and central banks will scrutinise data in parallel, but the former will react more quickly should inflation stay high.
Despite more than 80% of the adult Italian population having received a full vaccination schedule, the government has decided to introduce new constraints to keep the Covid-19 epidemic under control. At the economic level, the impact of this decision is likely to be felt most in the labour market, accentuating labour shortages, and particularly in the transport sector, where between 25% and 30% of workers still do not have the health pass, according to estimates from Confreta, the union for the industry.
The sections of our Pulse on industrial production and retail sales deteriorated significantly. This mainly reflects base effects linked to the catch-up in activity in the first half of 2021. In the coming months, household spending could be held back by the rise in energy prices, which shows no sign of slowing down, and possibly also by lengthening delivery times for certain products.
