Major Economies: Political uncertainties threaten nascent global economic recovery
March 29, 2017
The strong momentum in the global economy in Q4 has carried over to this year, according to available economic data for Q1. Global GDP is set to expand 2.8% year-on-year in Q1, matching Q4’s result. The recovery, however, appears to be uneven as developed countries are leading most of this year’s upswing in global growth, with robust domestic demand buttressing growth in the Euro area and the United States. While the former is benefiting from strong household spending due to a declining unemployment rate and an accommodative monetary policy, growth in the United States is being propelled by gains in household wealth and a turnaround in investment as a result of a rebound in oil-drilling activity. Despite subdued private consumption, a weak yen and a pickup in global demand are fueling economic activity in Japan.
China’s start to the year surprised market analysts on the upside, as a booming real estate market and stronger global growth are boosting manufacturing output and investment. In fact, Asian economies are benefiting the most from strengthening global trade, with exports in a number of countries expanding at multi-year highs at the start of the year. Latin America is gradually exiting recession, but growth remains sluggish as the region is highly vulnerable to external shocks, and structural weaknesses limit any sharp economic recovery. Finally, most oil-exporting economies are not yet feeling the effect of higher crude prices as some had to cut oil production in compliance with November’s OPEC deal.
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Despite the promising start to the year, a number of events are threatening the nascent global economic recovery. UK Prime Minister Theresa May will invoke Article 50 on 29 March, triggering the long-awaited Brexit process and sending the European Union and the United Kingdom into unchartered waters. Free movement of people between the island and the continent and the trade deal will be the cornerstones of the negotiation. Moreover, May will have to deal with the Scottish government’s plan to hold a second independence referendum before March 2019. The election cycle in Europe will also be in the spotlight as the emergence of anti-EU parties is threatening the stability of the European Union. Despite the defeat of right-wing populist Geert Wilders and his Party for Freedom (PVV) in the 15 March elections in the Netherlands, France is now heading to the ballot box on 23 April to choose a new president, with Marine Le Pen almost certain to make the second round of voting.
In the United States, the expected meeting between President Donald Trump and Chinese President Xi Jinping on 6–7 April has the potential to warm relations between the two countries and dispel fears of an open trade war between the world’s two largest economies. Nevertheless, uncertainty surrounding Trump’s commercial policies will continue to weigh on global trade prospects. Moreover, although the Federal Reserve recently delivered its second rate hike in three months, as markets expected, analysts believe that the Fed is more confident about inflation prospects and could accelerate its tightening cycle. This situation could fuel volatility in the financial markets, particularly in developing countries.
Global economy walking a tightrope
The FocusEconomics panelists left the 2017 global growth outlook unchanged for the eighth consecutive month, as global risks appear to be broadly balanced. With economic data for Q1 suggesting that the global economy is recovering at a healthy pace, news that a number of governments, notably China and the United States, will use fiscal policy to support the economy is posing upside risks to the world’s economic outlook. Although higher commodity prices will erode consumers’ purchasing power via rising inflationary pressures, they will also help replenish the empty coffers of some emerging-market nations. On the downside, spillovers from the triggering of Brexit, uncertainty regarding U.S. President Donald Trump’s trade policies and a faster-than-anticipated tightening by the U.S. Federal Reserve continue to weigh on global growth prospects. Following a 2.6% increase in 2016, analysts surveyed by FocusEconomics expect global economic growth to accelerate to 2.9% in 2017. For 2018, the panel sees growth strengthening further to 3.1%.
Taking a closer look at individual countries, this month’s global outlook for 2017 showed an upward revision to growth prospects for major economies such as Canada, Japan and the United Kingdom. The GDP growth forecasts were held stable for major players the Euro area and the U.S.
Among the major emerging economies, an upgrade to China’s economic outlook helped to stabilize economic dynamics in Asia ex-Japan. In Latin America, despite stable growth prospects for regional behemoth Brazil, mounting external headwinds and domestic challenges led the region’s economic outlook to deteriorate. This year’s growth estimates for Eastern Europe are benefiting from robust dynamics in the European Union and a brighter outlook for Russia. Although the increase in commodity prices bodes well for growth in the Middle East and North Africa and Sub-Saharan Africa regions, geopolitical threats, tight fiscal positons and perennial structural imbalances led our panelists to downgrade the outlooks for both regions.
UNITED STATES | Trump fails to repeal the Affordable Care Act
American households remain the linchpin of economic growth, underpinned by buoyant consumer sentiment readings and an exceptionally strong labor market. Although upbeat confidence has not been reflected in recent hard data—retail sales barely grew in February—accelerating wage growth and rising equity and housing prices are likely to boost consumer spending in upcoming months. Economic activity is firming elsewhere, with the ISM manufacturing index rising to an over-three-year high in February. However, little progress, if any, has been made on the fiscal front in recent weeks. Growing disagreements on the repeal-and-replace bill for the Affordable Care Act (ACA) have dominated news headlines. With Republicans focusing their efforts on ACA, a comprehensive tax reform plan is unlikely to be greenlighted anytime soon.
Growth is set to accelerate this year, buttressed by resilient household consumption and a surge in capital outlays on the back of upbeat business sentiment. However, a strong U.S. dollar and the robustness of the domestic market will likely see net trade drag on growth. Both upside and downside risks to the outlook will depend on potential policy shifts in Washington. FocusEconomics panel sees GDP expanding 2.3%, above 2016’s 1.6%. The outlook was left unchanged from last month. For 2018, the panel sees growth picking up slightly to 2.4%.
EURO AREA | Economy enters 2017 on strong footing
Momentum is clearly firming in the Eurozone’s economy. Robust domestic demand kicked the recovery up a notch in H2 2016, defying earlier expectations of a slowdown due to geopolitical uncertainties. An improving labor market, high confidence levels and ultra-loose monetary policy are acting as tailwinds for the domestic economy. Incoming data for Q1 suggest that growth has kicked into an even higher gear: economic sentiment rose to an almost six-year high in February and the manufacturing PMI surged further into expansionary territory in March. While the picture painted by recent data is sunny, political clouds are gathering. Although the far right failed to come out on top in the Netherlands’ March election, a highly fragmented parliament means that forming a solid and effective government will be tough. France will head to the polls on 23 April in an unpredictable race, with fall elections in all-important Germany to come. Against the backdrop of changing leaders, Brexit negotiations are slated to begin after the UK triggers Article 50 at the end of March.
A stronger global economy and firmer labor market will support a healthy expansion this year. However, rising inflation could take a bite out of consumer spending. The FocusEconomics panel sees 1.6% growth this year, which is unchanged from last month’s forecast. For 2018, growth is seen steady at 1.6%.
JAPAN | Strong exports continue to propel growth in Q1
A pickup in global demand and a weak yen continued to support the economy at the outset of the year. In February, exports expanded at a double-digit rate for the first time in over two years, pushing the trade surplus to levels last seen in 2010. Higher demand for Japanese goods is also boosting activity in the manufacturing sector. Against this backdrop, the manufacturing PMI remained firmly entrenched in positive territory in March. However, weaknesses that plagued growth in 2016 have also carried over to this year and despite the continuous fall in unemployment, sentiment among Japanese consumers remains downbeat in February. In a four-day trip to Europe in mid-March, Prime Minister Shinzo Abe and German Chancellor Angela Merkel called for the swift signing of the free trade deal between the European Union and Japan, in negotiation since 2013.
Although Japan continues to benefit from stronger global demand and a weak currency, risks are looming in the form of rising protectionist tendencies worldwide, a deterioration in China’s economy and weak private spending. Moreover, quicker monetary policy tightening in the United States could fuel financial volatility in emerging markets, prompting capital to flee to Japan and strengthening the JPY. Analysts see the economy growing 1.1% this year, which is up 0.1 percentage points from last month's projection. For 2018, they see growth at 0.9%.
UNITED KINGDOM | May ready to pull the trigger
The economy has stayed robust so far this year. Unemployment fell to a rate not seen in decades in January, while the manufacturing sector continued to expand in February, albeit at a reduced rate, as British firms felt the benefits of the lower exchange rate on exports. On the downside, wage growth slowed markedly in the three months to January, while the increase in inflation observed in recent months continued unabated in February. Coupled with the continuing tax credits and child benefits freeze, this will eat into consumer spending, which has remained resilient since the Brexit vote. On the political front, Chancellor Philip Hammond presented the 2017 budget in early March. Despite lower-than-anticipated public borrowing in 2016-17, the budget stance was neutral. The Chancellor reiterated the government’s commitment to gradually reduce the fiscal deficit through constrained spending increases and balance the books as early as possible in the next parliament.
Growth is set to slow this year, with uncertainty regarding the UK’s future relationship with the EU deterring investment. At the same time, low wage growth coupled with higher inflation will put a dent in private consumption. However, the Bank of England’s (BoE) accommodative monetary policy stance will soften the slowdown. Our panelists are forecasting 1.6% growth for this year, up 0.2 percentage points from last month’s forecast. For 2018, growth is projected to dip slightly to 1.3%.
INFLATION | Emerging markets cause global inflation to decelerate in February
Global inflation receded slightly in February to 3.8%, after hitting a multi-year high of 3.9% in January. February’s inflation reading reflected more stable macroeconomic conditions in emerging markets mainly due to higher commodity prices, which caused inflationary pressures to stabilize. Moreover, seasonal distortions related to the Lunar New Year holidays led China’s inflation to fall to an over two-year low. On the other hand, inflation in advanced economies continues to mount as a result of higher energy prices.
Despite February’s deceleration, inflationary pressures will resurface going forward as a result of the gradual increase in raw material prices and a modest pick-up in global growth. Higher inflationary pressures, coupled with the possibility of a quicker tightening process in the United States, will limit central banks’ ability to maintain their largely accommodative monetary policies. Most of the world’s major central banks will therefore keep key interest rates on hold this year or they could even adopt more of a tightening bias in order to prevent capital outflows and defend their currencies.
Higher commodity prices and stronger global growth will drive global inflation to accelerate to nearly a decade high this year. The FocusEconomics panel projects that global inflation will rise to 4.7% in 2017, which is up 0.3 percentage points from last month’s Consensus. In 2018, analysts see global inflation moderating to 4.1% mostly due to improving macroeconomic imbalances in emerging-market nations.
Written by: Ricard Torné, Head of Economic Research