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As we enter a second year under the shadow of Covid-19, a range of forces, forecasts, challenges and opportunities are all jostling for the attention of the world’s policymakers. Neil Parker discusses all of this in RBS International’s first quarterly economic update.
While political leaders focus on balancing protecting public health with the need to prevent economic scarring, central banks wrestle with the various monetary and fiscal responses to an unprecedented crisis.
And all the while, life goes on: with the pandemic as a backdrop, the UK and EU managed to agree a Brexit trade deal just before Christmas; China took steps to underpin its economic recovery; and US voters saw the chaotic exit of one president and the arrival of a new one.
Clearly, as Neil Parker, FX Market Strategist at NatWest Markets observed, 2021 is set to be a year of challenges, contradictions, conflict - but perhaps some recovery, too.
“The economic outlook has marginally improved on the original forecasts issued last year,” Parker said, presenting his look ahead for 2021 as part of RBS International’s first quarterly economic update.
“And the figures from the IMF do suggest that the rate of slowdown in global economic outlook was marginally slower than was previously estimated, at around 3.5%,” he said, although that figure was to some extent driven by China’s continued growth.
This year should offer a slightly more upbeat prospect: instead of the 5.2% level of global growth, the IMF expects it to be around 5.5%, slowing to 4.2% in 2022. Meanwhile, Parker said the UK can expect to grow by 4.5% in 2021, and that should accelerate in 2022, “which means the UK should recoup most of its lost economic output in the next couple of years”.
The changing face of recovery
So despite the gloomy winter, there are reasons for optimism, especially in the UK. The next six months, Parker explained, will likely see steady improvement in general conditions. “The state of the virus and the vaccine response will be critical,” he said. “And while there have been some supply issues around the vaccine rollout, progress is steady.
“It would seem likely that [there will be] a move towards a greater degree of normality. By the summer, we should see most, if not all, economies loosening restrictions, although we’ll still have a modified travel and tourist industry in the short term.”
And the impact of coronavirus will still be felt for a long time to come. For instance, the way we shop and entertain ourselves is likely to have been altered permanently by the pandemic. “The digital footprint of our consumption is likely to change materially,” said Parker. “Take retail, which, prior to the pandemic, we were running at around 20% of sales being done online. That number at [the] end of 2020 was almost 32%, and I don’t think we’ll go back to the low 20s.”
And while consumers will need to learn to live with some lingering restrictions – mandatory mask use is likely to continue – for governments and economists, the focus will be on how best to balance pent-up demand with the need to protect what may be a fragile recovery.
“It would seem likely that [there will be] a move towards a greater degree of normality. By the summer, we should see most, if not all, economies loosening restrictions, although we’ll still have a modified travel and tourist industry in the short term”
Neil Parker, FX Market Strategist, NatWest Markets
“We’ve seen zero interest rates for a long time, and that’s not likely to change anytime soon,” said Parker, who pointed out that the UK and US governments are committed to keeping the cost of borrowing as low as possible for at least another two years.
“All of the major economies – UK, US and Europe – will see a tightening of fiscal policy before monetary policy is changed. So that will come about once economies achieve pre-pandemic output levels because there’s a clear and consistent trend of rising inflation – and there are signs of progress in labour markets as well.”
Post-Brexit opportunities – and risks
Naturally, many in the UK will also be keenly watching the impact of Brexit in the coming months. Parker said it was too soon to offer a definitive answer as to whether the decision to leave the EU will benefit the UK, but we may well see some short-term gains. Indeed, there are already indications that businesses are looking at the UK in a positive light, regarding investment, following the trade deal concluded in late 2020.
“The medium- to longer-term outlook, though, will depend on the performance of the UK in terms of productivity and pricing,” Parker explained. “These will be determined by the labour market, investment and the GBP’s value. Can the labour market become more productive? Will investment automate labour-intensive roles? Will the GBP remain competitive, in terms of goods pricing relative to other neighbouring economies/developed rivals?”
However, while high levels of indebtedness may be forgiven as a short-term response to a crisis, in a post-Brexit world, UK government borrowing must be brought under control in the long term.
“For a country like the UK that has just detached itself from the EU, it’s clear that the risks of a debt crisis are higher there than in similarly sized European countries,” said Parker. “Ultimately, there is a limit of debt-to-GDP, beyond which the markets will punish you. Realistically for the UK, if it was running debt-to-GDP above 120% for a long period, that would be enough to spook investors.”
Beware the bubble
Managing investor sentiment through a period like this is also a tricky task, though Parker said anyone fearful over future bubbles should be aware that we are already in a bubble in terms of investor behaviour. “No longer are investors concerned about returns on equity and dividends, but rather on capital growth,” he said.
“However, in a zero interest rate environment, dividend returns and government bond yields may be less important to investors, especially given the amount of asset purchases being made by central banks to suppress yields.”
That’s not to say that equity markets won’t continue to appreciate, which looks likely given the lack of alternatives available to investors. But if the past 12 months have taught us anything, it’s that investors trying to predict the future should proceed with caution.
“Anybody should tread carefully with regard to stocks that have risen sharply in value if that valuation is based not on current performance but on expectations regarding the future,” Parker said.