The key word about foreign exchange in the global economy in 2022 is "recovery"

The global economy is still on the road of strong recovery from the epidemic crisis, which is good news before 2022. Less gratifying is that as governments implement new restrictions to cope with the emergence of new variants, the cycle in the coming months will be bumpy, and rising inflation will lead to differences in monetary policy, which may disrupt market order.

Global economic growth faces downside risks

We estimate that the global economic growth will slow down to about 4.5% next year from the estimated rapid rebound of 5.8% this year. However, the lower estimate is still much higher than its long-term potential of about 3%.

 

 

 

The risks facing the economic outlook in 2022 are mainly downward. The output of the world's largest economy will grow by about 3.5%, 4.4% in the euro zone, 3.6% in Japan and 4.6% in the UK. China will approach its long-term trend of 5%. Due to the base effect, although the high growth of China's economy from 2021 tends to normalize, it is also restrained by the restructuring of the real estate industry and the tightening of regulation.

The recovery of the global economy in this quarter and the first three months of next year may slow down moderately, if it is not for a complete decline in output, it is possible; Because governments, especially in Europe, with the development of Omicron variant, taking new measures to slow down the infection rate of the virus is the main reason. The restrictions on unvaccinated people are being gradually implemented, and the economic rebound should accelerate again by the spring of 2022.

In developed countries, a healthy medical system is still an effective guarantee to deal with the bottleneck caused by the pandemic. What is more gratifying is that as the government takes more targeted measures, the risks posed by the epidemic to economic recovery should continue to be mitigated over time; Although the Omicron variant has become easier to spread, its lethality has decreased, and businesses and people have adapted to work under stricter public health restrictions.

Inflation will ease gradually

As people gradually get rid of the pandemic crisis, inflation is worrying. Even after the sharp slowdown of price changes in 2022, the inflationary pressure may still be more persistent than expected by the central bank, and even higher than the pre crisis average.

The impact of higher and longer-lasting inflation on sovereign credit rating is good or bad. Higher inflation supports higher nominal economic growth, helps to reduce the ratio of debt to GDP, and reduces the long-standing deflation risk in the eurozone and Japan. However, rising interest rates have pushed up debt servicing costs, especially for governments with high debt and budget deficits. The currencies of emerging economies are weak and affected by capital outflows, especially at risk.

In this context, there will be obvious differences in monetary policy among the world's largest economies. As central banks withdraw some monetary stimulus measures during the crisis, this process may clarify the risks associated with high debt and foam asset prices.

This is especially true for Britain and the United States, where inflation may continue to test the central bank's demand to keep price increases at around 2%. The Bank of England and the Federal Reserve will raise interest rates next year.

In contrast, the Bank of Japan is much less worried about inflation. In the long run, the inflation rate in the eurozone may remain below 2%. The Bank of Japan and the European Central Bank are expected to maintain current lending rates throughout 2022. The European Central Bank will stop the pandemic emergency procurement plan next year, although it and other asset purchase tools may be adjusted when the market adjusts. Inflation in the eurozone rose sharply to 4.9% in November, which may test the determination of the European Central Bank to maintain policy easing.

 

 

 

In this regard, if high inflation increasingly limits the room for monetary manoeuvre, any weakening of the central bank's ability to stabilize financial markets may expose potential risks related to the debt accumulated in the past. According to the latest statistics of the bank for International Settlements, the non-financial sector debt of global reporting countries hit a new high of $225 trillion in the second quarter of 2021, equivalent to 273% of GDP.

Key drivers

Entering the first quarter of 2022, concerns about the development of Omicron variants and the impact of high inflation on the economy will continue to dominate the market and policy direction. Investors will want to know what measures the government and the central bank may take to curb price pressures and keep their economies running under the pressure of the latest virus related restrictions on economic activities.

With governments around the world increasing their fiscal expenditure significantly during the pandemic, it will be politically difficult to take further stimulus measures without raising taxes. Similarly, the central bank has also pushed itself to a desperate situation. Of course, with inflation so high, they will no longer be keen to increase bond purchases again. If anything, the Fed may not even wait until the middle of next year to raise interest rates.

The divergence of monetary policy brings pressure to the central bank, otherwise the central bank is unwilling to tighten policy to protect the currency from further depreciation, which may further aggravate the pressure to support inflation. The central bank now holds large amounts of government debt. The resulting fiscal dominance may slow the normalization of monetary policy, although any such delay may exacerbate inflation risks.

However, we should not be too pessimistic. Monetary policy innovation during the pandemic, such as the flexibility introduced by the European Central Bank through PEPP, enhanced the flexibility of sovereign borrowers in the crisis stage, assuming that such innovative monetary instruments can be used to redeploy in the future economic downturn.