Monthly Economic Monitor July-August 2021


By Matthieu Arseneau and Jocelyn Paquet

After substantial progress in the struggle against Covid-19, the world faces a new enemy in the Delta variant. The new threat seems to have led many investors to question the possibility of vigorous recovery of the global economy and to go back to safe-haven vehicles such as USD-denominated bonds. Is the market justified in its fears for world output? Our answer to this question varies according to the degree of immunity attained in each region. In developed economies, where vaccination rollouts have been moving right along, Delta could bring a rise in new cases without overwhelming health-care systems. Since the main aim of public-health restrictions in developed countries has always been to avoid hospitalizations and fatalities rather than to prevent spread, current conditions are still consistent with a gradual reopening. The outlook for the emerging countries is not so upbeat. Their lag in vaccinations increases the risk that one or more of them will go where India went earlier this year. Though far-reaching restrictions are fairly rare in the emerging economies, the virus could still poop the party by forcing more localized restrictions. Despite a rise in uncertainty, we have left our global growth forecast unchanged for both 2021 (6.0%) and 2022 (4.5%).

The U.S. economy is recovering fast. After an expansion of 6.4% annualized in the first quarter of the year, we expect Q2 to show an acceleration to about 10%. As in recent months, household spending is likely to be the main driver. Business investment should also contribute to growth. Residential investment, meanwhile, could be set for a pause after several months of frenetic activity. Though we think the labour market is in better shape than some of the data would suggest, it will take more time for the upside effects of reopening to be fully reflected in the numbers. That will allow the Fed to keep its monetary policy extremely accommodative in the coming months. The median forecast of FOMC participants suggests that short-term interest rates will remain abnormally low relative to the output gap through to the end of 2023. Under these conditions, the U.S. economy is likely to continue outperforming over the longer term. We continue to see real GDP growth of 6.9% this year and 4.3% next year. At our forecast horizon (end of 2022), that would mean output exceeding potential by 2.1%, the largest gap since 1978. A gap that wide does not seem consistent with a return of inflation to the 2% target. For this reason, we forecast core CPI will remain comfortably above 2% at least until the end of 2022. In the meantime, inflation excluding food and energy could peak around 4.1% in 2022Q1.

Though many are apprehensive of a fourth wave of Covid-19, recent data for Canada are highly encouraging. Canadians have responded very positively to vaccine rollout and the share of the population that has received at least one dose is one of the word’s highest. Hospitalizations falling sharply in recent weeks have allowed an easing of public-health restrictions. After a moderation of expansion in Q2 due to public-health measures and to production issues in auto making by reason of the chip shortage, impressive growth continues to be expected with the coming reopening of services entailing close physical proximity. This month we are keeping our forecast of 2021 growth at 6.0%. In nominal terms, our forecast remains 12.6%, unseen in 40 years. Forest-product prices have subsided considerably but soaring natural gas prices drove the Bank of Canada commodity price index to a 13-year high in July. In this context, the labor market is expected to recover rapidly in the coming months as hiring intentions and labor shortages suggest strong employer demand.

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