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The world economy at a critical junction – continued recovery amidst high inflation

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    9 February 2022

    In 2022, the global economy is expected to further recover from the severe recession caused by the coronavirus pandemic. Current high rates of inflation should gradually recede. However, uncertainties remain elevated.

    This is the conclusion reached by Munich Re’s Economic Outlook for 2022. While the pandemic has brought the most severe recession in modern economic times, the recovery of the world economy in 2021 was remarkably fast and strong – with record high growth rates, but also supply chain distortions and high inflation. Several major economies, including the US, have already reached the level of economic output (GDP) they had prior to the crisis.

    The key forecasts of Munich Re’s Economic Research:

    • In 2022, the global economy is estimated to experience real (i.e. inflation-adjusted) GDP growth of 4.1%, following very strong growth of 5.6% last year, which was driven in particular by the pandemic-related economic downturn in 2020.
    • Current high inflation rates in many developed countries are expected to gradually fall in the course of 2022. However, annual average inflation rates will remain relatively high, similar to 2021. In the medium term, inflation is forecast to stay well above pre-pandemic levels, which were fairly low, especially in the eurozone. The risk of higher-than-expected inflation in the next few years is also significant.
    • In the short term, the most relevant risk comes from further disruptions to global supply chains – an Omicron wave in China, for example, could lead to supply chain bottlenecks lasting longer than expected. This would result in continuing inflationary pressure, with negative effects for the economy. In this case, growth rates could turn out to be up to 2 percentage points lower in 2022 than forecast in the baseline scenario. Average annual inflation in many cases would then also turn out to be at least 1 percentage point higher than expected for this year. Further sharp increases in energy prices, for example as a result of the Russia-Ukraine conflict, could also trigger correspondingly higher inflationary pressure.

    Where does the global economy stand?

    Strong demand, high commodity and energy prices as well as supply chain bottlenecks have caused prices to rise more sharply than they have in a long time. In December, the US inflation rate reached 7%, its highest value for around 40 years. In the eurozone, inflation reached 5.1% in January 2022, its highest level since the monetary union started in 1999.

    High inflation has a considerable impact on key parts of insurers’ business due to increasing claims costs. What’s more, in many countries construction costs have risen significantly more than is apparent in consumer prices. This makes reinstatement costs more expensive in the event of claims.

    In the baseline scenario for 2022, a continued strong recovery amidst high, but decreasing inflation is expected. Nevertheless, annual average inflation rates in advanced economies will clearly remain above the 2% target level used by many central banks. In addition, the road to recovery will be bumpy. The rampant Omicron variant and supply bottlenecks are currently slowing down economic growth in many countries. As these headwinds should fade over the coming months, growth dynamics are expected to return.

    However, downside risks, in particular regarding the pandemic and global supply chains, are elevated and could even lead to a stagnation-like scenario with persistently high inflation and low economic growth. In addition, potential geopolitical tensions could weigh on financial markets and negatively affect energy and commodity markets.

    This high uncertainty comes at a time when fundamental drivers of inflation are changing. The times of ultra-low inflation are likely over and bond yields have already gone up. The US Fed and the BoE are already in the process of ending their unprecedented monetary expansion and have signalled or even initiated central bank rate hikes. To do so will be delicate for the ECB due to the potential impact of increasing interest rates for highly indebted eurozone countries.

    Michael Menhart, Chief Economist at Munich Re, explains the background:

    Background to the Economic Outlook for 2022
    (transcript of the video)

    “The key features of the status quo are high growth, high inflation and high uncertainty regarding its future course. The pandemic has brought the most severe recession in modern economic times. However, the recovery was strong and fast, and this despite the fact that the virus is still there. The global economy has been growing with a record 5.6% in the year 2021 after a contraction of 3.4% in the year 2020.

    Thus, the world economy has reached the level of economic activity it had before the pandemic already now. This is truly remarkable. However, this very strong economic growth, while the pandemic is still ongoing, has also brought new issues. For example, supply chain bottlenecks: in many industries, companies are not able to produce enough to meet the high demand.

    Unemployment rates have been falling strongly, and we see a shortage of labour in many industries, potentially implying higher wage growth. Inflation rates have gone up significantly in most advanced economies. We are facing now price increases we have not seen for many years.”

    “The uncertainty on the economic outlooks is very high. For example, it is not yet clear how much and how long the pandemic will impact economic activity, and we have additional geopolitical uncertainties, such as the conflict between Russia and Ukraine. The world economy is at a critical junction right now between a positive scenario with continued recovery and a moderation of inflation rates, and a negative scenario with persistently high inflation and a decrease of economic growth.

    For the positive scenario to materialise we would need to see the pandemic not again dragging down economic growth, supply chain distortions easing up, and no major disruption due to geopolitical events or other adverse developments. If this is the case, then we would expect a positive year 2022 with continued strong growth. Global economic activity this year will be 4.1% higher than last year, and this will be mainly driven by consumers in advanced economies such as the USA or the eurozone, who currently sit on large amounts of accumulated savings from money they could not spend at the height of the pandemic.

    On top of that, we expect companies to increase investments and also build up inventory. We consider this our baseline scenario since we think it is the more likely one. Here’s why: First of all, supply chain distortions are easing up slowly but measurably. On top of that, corona measures, especially in the northern hemisphere, will have a dampening effect on economic activity for some months to come.

    However, they are not as strict as one year ago.

    What will this positive growth scenario mean for the insurance industry? The continued recovery will also bode well for premium growth. What about inflation in this scenario? Inflation will be high in the year 2022, at least compared to central bank targets of 2%. We expect an inflation rate of 4.6% in the USA and 3% in the eurozone on average over the year, with lower levels at year-end.

    This is lower than the record high inflation rates we saw in the last months of 2021, when inflation hit more than 7% in the US and more than 5% in the eurozone. However, energy and commodity prices moved up sharply in the year 2021. It would need further substantial increases to keep those record high levels of inflation – something that we do not expect to happen.” 

    “Persistently higher inflation rates and low economic growth. In our downside scenario, we would expect the global economy to only grow by 2.5%. Inflation rates would be very high – 5.7% for the USA in the year 2022, and 4% for the eurozone. We believe that risks to global supply chains are the most imminent threat.

    For example, should the zero-Covid policy of China lead to more widespread lockdowns and also affect harbours, then global supply chains would be hurt once again. If people would then realise that elevated inflation is not a short-term phenomenon, then inflation expectations could rise, pressure for wage growth could increase, and this could imply a wage-price spiral that reminds us of the 1970s.

    Then we could see higher inflation for several years. Thus, it is developments on the labour markets that need close monitoring. This is especially true for the USA, where we have already seen strong wage growth in the year 2021, different from Europe. All this uncertainty occurs at times when fundamental drivers of inflation are changing; the disinflationary forces from global competition and cost-efficient supply chains are likely to be weaker in the future.

    At the same time, the urgently needed decarbonisation of our economies brings the risk of higher volatility in energy prices and thus renewed periods of inflationary pressure from energy and commodity markets.” 

    Munich Re assumes no guarantees as to the accuracy of this data, which is collected as of specific dates and can also change at any time. The information should not be used as the basis for any decision without prior professional advice and careful contextual analysis. Munich Re is not liable for damages arising from any decisions that third parties may take on the basis of this information.
    Contact our experts
    Michael Menhart
    Michael Menhart
    Head of Economics, Sustainability and Public Affairs
    Oliver Büsse
    Oliver Büsse
    Head of Economic Research

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