Major Economies Economic Outlook July 2018

Major Economies: Economic Snapshot for the G7 Countries

June 26, 2018

Trade war threatens global economic growth this year


Comprehensive data revealed that economic growth remained robust in Q1, with the global economy expanding 3.5% annually for the third consecutive quarter. While global growth in Q1 was overall propelled by tightening job markets, largely accommodative financial conditions, higher commodity prices and still-resilient trade dynamics, a regional breakdown shows emerging markets took the lead at the outset of the year.


Meanwhile, economic data for Q2 suggests that global growth will have decelerated slightly in the quarter, as the driving factors that have propelled worldwide economic growth since late 2016 start to wane. The global trade cycle appears to have peaked in Q1, while further massive gains in the labor market are highly unlikely as unemployment is gradually reaching pre-crisis rates. In the Euro area, ongoing political unrest continues to weigh on growth, with political crises in Italy and Spain and disagreements over migration policies topping the agenda. Moreover, the recently announced unwinding of the European Central Bank’s (ECB) quantitative easing (QE) program adds further uncertainty to the Eurozone’s economic outlook. In the United Kingdom, the economy is still suffering from uncertainty related to Brexit, which is hurting investment activity. Sluggish wage growth in Japan is inhibiting a sustainable economic recovery. The United States, however, represents the silver lining, with an economy firing on all cylinders due to an ever-tightening labor market, firm business investment and lower taxes. Against this backdrop, our analysts project that global growth will ease slightly to 3.4% in Q2.


Furthermore, downside risks to the global economic outlook have risen in recent weeks. Trade tensions are rising following the U.S. decision to impose tariffs on USD 34 billion of Chinese imports effective on 6 July and putting an additional 16 billion in tariffs under review. China quickly retaliated and imposed tariffs of the same magnitude on U.S. imports. The U.S. administration is also targeting long-time allies. On 1 June, the U.S. enacted tariffs on imports of aluminium and steel imports from the European Union and NAFTA partners Canada and Mexico. In response, the three countries unveiled tariffs against selected U.S. imports. The war of words continued in the following days, with President Trump threatening to impose additional tariffs and sanctions on all countries that unveiled retaliatory tariffs against the United States. Trade affected by actual tariffs is relatively low for now. However, if the escalation continues, the global economy will edge closer to a full-blown trade war among major economies, which could seriously undermine growth.


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Global economic outlook held steady despite rising trade disputes


Although our panel of analysts left the outlook for the global economy unchanged at 3.4% growth in 2018 for the fifth consecutive month, risks to the outlook are quickly skewing to the downside. Fears of a trade war; rising energy prices; tightening financial conditions, especially following the ECB’s decision to end its bond purchasing program in December; and widespread political uncertainty in countries such as Argentina and Brazil are paving the way for a downgrade to the global economic outlook in the coming months. In 2019, the world economy is expected to expand at a broadly steady rate of 3.3%.


 


This month’s stable outlook for the global economy reflects unrevised growth prospects for the United Kingdom and the United States. Weaker-than-expected growth in Q1, along with rising trade tensions, led our analysts to downgrade the economic outlooks for Canada, the Eurozone and Japan.


Despite risks of a full-blown trade war between China and the United States, the economic outlook for the Asia (ex-Japan) region was left stable this month as economic dynamics in regional powerhouses China and India remain strong. Eastern Europe continues to benefit from resilient growth in the Euro area and the economic recovery in Russia. That said, persistent political unrest and unsustainable economic stimulus in countries such as Romania and Turkey are threatening growth in Eastern Europe. Despite firmer commodity prices and low inflation, persistent political turmoil in Argentina and Brazil continue to cloud the outlook for Latin America. While higher commodity prices bode well for growth in the Middle East and North Africa, and Sub-Saharan Africa regions, large economic imbalances and persistent geopolitical risks continue to put a dent in the regions’ economic activity.


UNITED STATES | Trump sends the U.S. economy into uncharted waters


Economic growth appears on track to record a stellar performance in Q2, fueled by strong business investment, tax cuts and an ever-tightening labor market boosting consumer spending. In May, the unemployment rate hit a new low, and growth in retail sales accelerated as consumer confidence remained near a historic high. Furthermore, housing starts picked up in the same month, helped by rising wages and lower taxes boosting household incomes. Survey data for May indicates the private sector has so far been unfazed by current tensions with trade partners, although President Trump’s rapidly escalating rhetoric vis-à-vis China in past weeks could prove damaging to business confidence. The month ahead might represent a critical junction, as new restrictions on investments between Chinese and American firms are set to be unveiled on 30 June, while reciprocal tariffs with China and retaliatory measures from Canada will take effect in early July.


The exceptional domestic momentum has so far been unmarred by signs of moderating growth in key trading partners. Although recent tariff measures will likely have minimal impact, the increasingly likely escalation of the dispute with China into a trade war is a major downside risk, which could weigh on business sentiment and investment. Faster monetary policy tightening and high fiscal deficits should further dampen growth in the medium-term. FocusEconomics panelists see GDP expanding 2.8% in 2018, unchanged from last month’s estimate. In 2019, growth is seen moderating to 2.4%.


EURO AREA | Economy recovers timidly from Q1’s soft patch amid rising trade disputes with the U.S.


Comprehensive data confirmed that the Eurozone economy lost steam in Q1, growing at the weakest pace since Q2 2016. The external sector was primarily behind the slowdown, with a strong euro and slowing global recovery fueling a decline in overseas sales. Data for Q2 suggests that momentum has regained some lost ground, although growth is likely still below last year’s highs. The unemployment rate hit a new multi-year low in April, and strong services sector growth pushed the composite PMI up in June. That said, data for the manufacturing sector has been weak, with industrial production contracting in May and the manufacturing PMI falling to an 18-month low the month after. Moreover, the outlook for the sector has turned gloomier in recent weeks. On 22 June, U.S. President Donald Trump threatened to slap a 20% tariff on all European Union manufactured automobiles if retaliatory tariffs on U.S. goods enacted by the EU were not lifted. While the U.S.’s initial tariffs on steel and aluminum are expected to have a relatively small economic effect, the automobile industry is a much larger sector and tariffs could dampen manufacturing activity.


FocusEconomics panelists cut 0.1 percentage points off the Eurozone’s growth forecast for 2018 this month and now see GDP growing 2.2% in 2018. A weak first quarter and rising political risks are dampening the outlook, although growth is expected to remain healthy overall thanks to a solid domestic economy. In 2019, the economy is seen expanding 1.9%.


JAPAN | Economy regains some momentum in Q2


Although the economy appears to be recovering from the soft patch in Q1, recent data suggests that the rebound will be weaker than expected. Despite remaining firmly entrenched in positive territory, the Q2 average for the manufacturing PMI was lower than in Q1, likely due to rising global trade uncertainty. Moreover, consumer confidence remains constrained by disappointing income growth. Export growth remained relatively robust in the first two months of Q2. However, rising trade protectionism in the United States, which enacted tariffs on aluminium and steel imports from Japan, and evidence that the global tech cycle likely peaked in Q1 pose downside risks to Japan’s external sector. Meanwhile, the Japanese cabinet approved on 15 June a new mid-term fiscal plan that pushes back from 2020 to 2025 the goal of achieving a primary budget balance and removes an important spending cap. While the plan was widely expected, it delays efforts to reduce the country’s massive public imbalances.


Japan will continue to benefit from the Bank of Japan’s (BoJ) ultra-loose monetary policy and a tightening labor market. Moreover, investment should remain robust in the wake of works related to the 2020 Tokyo Olympics. There are, however, notable downside risks: Rising protectionism could undermine the performance of the all-important external sector. Moreover, mounting geopolitical risks threaten to strengthen the yen. FocusEconomics panelists see the economy growing 1.1% in 2018, which is down 0.1 percentage points from last month’s forecast, and 1.0% in 2019.


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UNITED KINGDOM | Economic growth gains steam in Q2, although Brexit uncertainty looms


The economy appears to have regained some momentum in the second quarter following a weak first quarter, but growth is still mediocre at best. Both the manufacturing and services PMIs picked up in May, although weak new orders growth and gloomier business sentiment bode poorly for the evolution of the services PMI going forward. In addition, consumer sentiment improved in the same month, while in February–April employment continued to surge. On the downside, most new jobs were part-time, with total hours worked declining slightly. In addition, the tight labor market is still not feeding through to significantly higher pay—likely driven by weak productivity. On the political front, Brexit negotiations are making little headway on the key sticking point of the Irish border ahead of an important EU summit at the end of June. This comes against a backdrop of disagreement in parliament over MPs’ role in the Brexit process.


 


Looking ahead, growth will remain muted, with fixed investment dampened by Brexit uncertainty and export growth slowing after the boost provided last year by the weaker pound. However, a slight pick-up in government spending and a loose monetary stance should support the economy. Our panelists estimate GDP growth of 1.4% in 2018, unchanged from last month’s forecast, and 1.5% in 2019.


INFLATION | Higher commodity prices fuel global inflation in May


The upward trend in commodity prices such as oil and food, along with reduced global economic slack, drove up global inflation in May. According to an estimate produced by FocusEconomics, global inflation rose from 2.5% in April to 2.7% in May. The increase was broad-based, as inflation firmed in both developed and emerging economies, with the Eurozone, India and the United States recording noticeable gains in May.


Higher price pressures and strong economic dynamics led the U.S. Federal Reserve to hike the federal funds rate at its 12–13 June meeting. Moreover, the Fed presented a brighter economic outlook for this year, signaling that a fourth hike this year is becoming increasingly likely. Although the Bank of Canada left its overnight rate unchanged at the 30 May meeting, the Bank signaled a rate hike in the upcoming meeting in July on the back of rising inflation and stronger growth.


On 14 June, the ECB announced the end of its QE program by the end of this year. While the Bank stated that the key interest rates will remain at current levels “at least through the summer of 2019”, the message was cautious, and the ECB’s ultra-low interest rates will remain in place in the short term. The Bank of England left its key rate unchanged at its 20 June meeting, although expectations for an August rate hike have risen slightly. The Bank of Japan is still far from any monetary policy normalization as inflation remains subdued despite the rally in energy prices. Therefore, the Bank left its stimulus program unchanged at the 14–15 June meeting. Meanwhile, China delivered a targeted cut in the amount of cash that some banks must hold (reserve requirement ratio) on 24 June to boost credit to businesses amid a looming trade war with the U.S.


Higher prices for some commodities, particularly energy and food, are expected to push up inflation in the coming months. That said, inflation risks are skewed to the upside due to the potential impact of pass-through effects from tariffs. The FocusEconomics panel sees global inflation at 2.9% for 2018, which is up 0.1 percentage points from last month’s estimate. Next year, the panel projects that inflation will inch down to 2.7%. If the hyperinflation episode in Venezuela is factored in, global inflation will reach 302% in 2018 and 8.6% in 2019.


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Ricard Torné


 


Head of Economic Research


 

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