Major Economies: Uncertainty reigns suprem
August 31, 2016
Two months have passed since the Brexit vote and, although the dust is gradually settling, the external environment remains challenging. The global economy slowed in the second quarter and financial markets had another rocky month in June when the UK voted to leave the EU. Risky assets, such as equities and commodities, declined sharply, before swiftly recovering as fears of imminent spillovers to the global economy receded. Following the vote, market expectations for a more accommodative monetary policy stance around the world increased, which, in turn, spurred risk appetite to rise even higher: equities around the globe have reached new record highs and commodities prices, led mainly by crude oil, have returned to the gradual recovery path which was briefly interrupted by the aftermath of the Brexit vote.
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The global economy was, however, already fragile before the Brexit vote. Preliminary data suggest that global economic activity decelerated in the second quarter. An estimate produced by FocusEconomics showed that global GDP slowed from a downwardly-revised 2.5% year-on-year increase in Q1 (previously reported: +2.6% year-on-year) to a 2.4% expansion in Q2. The revision in Q1 and the Q2 deceleration reflect, in part, slower growth in China’s economy, which has contributed to weaker global trade and industrial production. This has weighed heavily on commodities prices, creating significant challenges for commodities exporters, including a large number of emerging economies.
Advanced economies have fared better, although most central banks in these economies are struggling with low inflation. Low commodities prices, especially oil, have been a key factor of the current disinflationary situation in the advanced economies. In response to this, many central banks have reduced interest rates to ultra-low levels—even below zero in some cases—and further monetary policy easing is priced in by the markets, apart from for the U.S. The U.S. economy remains the outlier among advanced economies, with the debate about when the next rate rise will be. Recently, all eyes were on the annual Jackson Hole conference, where Janet Yellen, head of the Federal Reserve, stated that the case for an increase in short-term interest rates has strengthened on the back of robust growth in the U.S. labor market. This indicates that the Fed is likely to make a move in the coming months and potentially as soon as September. However, disappointing GDP growth in the first half of 2016 and heightened uncertainty regarding global risks suggest that the pace of tightening will be gradual.
Going forward, the global economy is expected to gain gradual momentum, boosted mainly by stronger growth in the U.S. economy and improving conditions in battered emerging economies. The U.S. economy is foreseen strengthening in the second half, buoyed by solid private consumption and a bounce-back in inventories. Moreover, the difficult economic conditions that key emerging markets, such as Brazil and Russia, experienced last year and in the first half of this year are gradually abating. Meanwhile, the Chinese economy stabilized in the second quarter as the resurgence of growth has been fueled by rising credit and a surge in government spending. However, the recent impulse to growth does not look sustainable and economic activity is set to slow in the coming quarter.
Uncertainty weighs on global outlook
The path forward is fraught with uncertainty and the UK’s vote to leave the EU has skewed the risks to the downside. While volatility has eased somewhat, long-term government bonds have fallen to multi-year lows, spurred by expectations of looser monetary policy around the world. The current global financial markets’ optimistic backdrop is not based on an improvement in economic fundamentals. As mentioned before, the global economy remained weak in the first half of the year and is expected to gain gradual momentum only in the coming quarters. Even assuming that the Brexit vote will have a limited impact on the world’s economy this year, the analysts we surveyed this month project that the global economy will slow from a 2.8% rise in 2015 to a 2.5% expansion in 2016. This month’s projection was cut by 0.1 percentage points from last month’s projection and for 2017, the FocusEconomics panel forecasts that global economic growth will pick up to 2.9%.
Among the major economies, this month’s global outlook for 2016 reflected a cut to the growth forecasts for the U.S. economy, while projections for the Euro area were left unchanged. Analysts raised their forecast for the United Kingdom as they had already taken into account the consequences of the Brexit vote in previous publications and remain in wait-and-see mode, following the Bank of England’s more expansionary monetary policy. In Japan, although the government announced a massive stimulus program to boost economic growth this year, analysts remain skeptical about whether the plan will be successful. Consequently, they leftJapan’s economic outlook unchanged over the previous month.
Among developing economies, the economic outlook for Asia ex-Japan remained unchanged. Latin America’s dismal economic outlook also remained unchanged as panelists are less pessimistic about the outlook for Brazil, although Venezuela continues to be a ticking bomb. In Eastern Europe, a less negative outlook for Russia is supporting growth prospects in the region, although spillovers from the Brexit vote are expected to hit some countries in Central Europe going forward. Lastly, the recent rebound in commodity prices following the Brexit vote has prompted the outlook for the Middle East and North Africa to stabilize. In contrast, the Sub-Saharan Africa region continues to be threatened by volatility in the financial markets and security concerns.
UNITED STATES | Economic growth disappoints in H1, Hillary Clinton leads in the polls
The U.S. economy firmed up in Q2 but growth was still disappointing. According to a second estimate, GDP increased at a seasonally-adjusted annualized rate of 1.1% (previously reported: +1.2% SAAR). The result was above the 0.8% increase in Q1 and showed that private consumption continued to be the main source of growth. Data also showed that fixed investment and government spending contracted, while exports rebounded. July payrolls increased strongly, providing reassurance that the U.S. labor market remains solid, whereas growth in retail salesand the manufacturing sector declined in the same month. Going forward, household spending is likely to continue boosting economic growth on the back of buoyant consumer confidence, solid employment and faster wage growth. The latest polls indicate that Donald Trump’s approval rating has fallen behind that of Hillary Clinton, but political analysts suggest the game is not yet over.
The U.S. economy is expected to strengthen in the second half, buoyed by solid private consumption and a bounce-back in inventories. Nonetheless, a persistently strong U.S. dollar and prospects of further weakening in the global economy will restrain growth in export-oriented industries, while low oil prices will continue to weigh on fixed investment. Analysts expect GDP to increase 1.7% in 2016, which is down 0.2 percentage points from last month’s forecast. For 2017, our panel sees GDP growth at 2.1%.
EURO AREA | Latest health check of European banks eases concerns
After a positive start to the year, growth in the Eurozone economy halved in the second quarter. While a breakdown by components is not yet available, the slowdown was likely partly due to temporary factors as growth in Q1 benefited from a mild winter and the early timing of Easter. Available data for Q3 has demonstrated resilience in the face of heightened concerns over the impact of Brexit on the economy. Economic sentiment rose in July and the composite PMI hit a seven-month high in August. In addition, the region’s banks showed a relatively clean bill of health in the European Banking Authority’s latest stress tests. The results revealed on 29 July showed that all but one of the 51 lenders tested—Italy’s Banca Monte dei Paschi di Siena—had enough capital to withstand the toughest scenario.
Healthy domestic dynamics should support a robust expansion in the Eurozone economy this year, as low oil prices and supportive monetary policy provide a buffer for consumption. Our panel sees the Eurozone economy expanding 1.5% in 2016, which is unchanged from last month’s forecast. For next year, our panel sees the economy decelerating slightly to 1.4% growth.
JAPAN | Cooling economy prompts government to unveil fiscal stimulus
Weak wage growth, an uncertain global economic outlook and a strong yen limited growth in the second quarter, with GDP expanding at a paltry 0.2% quarter-on-quarter seasonally-adjusted annualized rate. Against this backdrop, the government unveiled a JPY 28.1 trillion (USD 269 billion) stimulus package in an attempt to jumpstart the economy. The plan mainly targets Japan’s challenging demographics, infrastructure projects and reconstruction in earthquake-hit areas. While the program represents the largest fiscal stimulus since 2009, analysts warn that fresh spending only amounts to JPY 7.5 trillion. More recent data suggest that the strong yen is hurting the external sector as exports contracted at the fastest pace since 2009 in July.
Despite massive fiscal and monetary policy stimulus, its slow implementation and the absence of decisive structural reforms are curtailing Japan’s ability to boost economic growth. Moreover, a strong yen and global economic uncertainties represent important downside risks to the economic outlook. Analysts see the economy growing 0.5% this year, which is unchanged from last month's projection. Next year, they see growth at 0.8%.
UNITED KINGDOM | Business as usual after the referendum?
The UK’s economy is beginning to stabilize following June’s Brexit vote. Although post-referendum data are still being released, both yearly and monthly retail sales growth in July indicate that British consumers were unfazed by the EU referendum result. Shares in construction companies have benefited indirectly from the Brexit vote: pressure on housing prices increased after the Bank of England (BoE) cut its Bank Rate and expanded its quantitative easing program in August. The BoE’s move has also boosted UK equities, which have recovered most of their post-referendum losses. Despite these positive signs, the British economy is not yet in the clear.The PMI and consumer confidence fell to multi-year lows in July as the uncertainty over how Brexit will play out is still a major source of concern for businesses and consumers, suggesting that even though retail sales in July were strong, sales could drop in the future as the decline in confidence takes hold.
Uncertainty stemming from the Brexit vote will continue to deter investment, but accommodative policy action taken by the BoE will soften the impact. Our panel expects the economy to grow 1.5% in 2016, which is up 0.1 percentage points from last month’s estimate. For 2017, the panel projects that the economy will grow 0.3%.
INFLATION | Global inflation stabilizes at two-year high in July
Global inflation remains on a gradual upward trajectory. An estimate produced by FocusEconomics shows that global inflation stabilized in July after rising to 3.1% in June. At this rate, global inflation remains at the highest level since August 2014. An increase in inflation reflects the gradual recovery in commodities prices after they lost some ground in the aftermath of the UK referendum, as well as higher inflation in emerging markets. Conversely, advanced economies continue to grapple with disinflationary pressures. Against this backdrop, major central banks in advanced economies are keeping a loose monetary policy, while in the emerging world, central banks are starting to tighten the reins.
Taking these developments into account, our panel of economic experts foresees that global inflation will continue rising and average 3.5% in 2016, which is up 0.1 percentage points from last month's estimate. For 2017, the group on surveyed analysts expect global inflation to rise further to 4.1%.
Written by: Ricardo Aceves, Senior Economist