Major Economies: Has the time come for fiscal stimulus?
September 28, 2016
Global growth remained tepid in the first half of 2016. An estimate produced by FocusEconomics shows that the world’s GDP increased 2.4% year-on-year in Q2 2016, which followed a 2.5% rise in Q1. According to the estimate, global economic activity has been slowing uninterruptedly since Q1 2015 and Q2’s result marked the weakest rate since Q1 2013. This deteriorating trend is mainly the result of a deceleration in emerging economies, particularly in China and in commodity-dependent economies in Latin America, the Middle East and North African region, as well as Sub-Saharan Africa. Advanced economies have fared better, although they too are now showing signs of fatigue. As a result, global trade, investment, productivity and wages remained depressed with no signs of immediate improvement in the second half of the year.
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Eight years after the collapse of Lehman Brothers triggered the acute phase of the global financial crisis, major central banks are still bearing the strain of keeping the world economy on track. In the developed world, interest rates remain at (or close to) record lows and several central banks continue to experiment with pioneering monetary policy—zero interest rate policies, negative interest rates and quantitative easing—in the hope of bolstering demand by lowering the cost of borrowing as much as possible. While these policies have supported growth, they have also introduced distortions in the global financial markets and asset prices. There is also widespread concern among analysts and policymakers that developed economies will struggle to withdraw from such generous conditions. The possibility of using expansionary fiscal policy has been tabled recently, but it is still all talk with very little action.
The U.S. is the only advanced economy that has begun to normalize its monetary policy, via a 25 basis-point interest rate increase in December last year. However, the Federal Reserve has been wavering about the prospect of a second rate move this year after being struck by heightened volatility in the financial markets. Meanwhile, the European Central Bank announced an extension of its quantitative easing program and a further relaxation of interest rates earlier this year, which are expected to remain in place until next year. The Bank of Japan recently modified its monetary policy framework in order to focus on two new directions: in addition to anchoring short-term interest rates below zero, a flexible asset purchasing program will be used to manipulate the entire yield curve so that it remains appropriately upward-sloping rather than flattening excessively. It is becoming clear that monetary policy is reaching its limits and that the time has come for governments to take action, with a number of analysts agreeing that the current environment is well suited for more spending. Borrowing conditions are exceptionally benign for solid sovereigns at a time when prices for commodities required for large infrastructure projects—steel, iron ore and oil—remain low.
Weakness to persist this year before a mild uptick next year
The global economy is expected to grow at a slower pace this year than in 2015, with a modest uptick projected in 2017. The analysts we surveyed this month left their 2016 global growth forecast unchanged from the previous month and expect it to expand 2.5%. The outlook suggests that the period of tepid growth observed in the first half of the year has taken root. Signs of weakness have begun to appear in some advanced economies, while the economic deterioration in some emerging economies has slowed. Next year, the Consensus view among analysts is that the global economy will pick up momentum and GDP will increase 2.9%.
Among the major economies, this month’s global outlook for 2016 reflects an unchanged GDP growth projection for the Euro area. Meanwhile, analysts raised the forecasts for Japan and the United Kingdom—as they had already taken into account the consequences of the Brexit vote in previous publications—whereas they cut the projections for Canada and the U.S. economy.
Among emerging economies, the outlook for most regions—Asia ex-Japan, Eastern Europe, Latin America and the Middle East and North Africa—remained unchanged. The only region for which analysts cut the 2016 growth forecast was Sub-Saharan Africa, which continues to be threatened by a slow recovery in commodities prices and security concerns.
UNITED STATES | Two-speed economy persists ahead of elections
The world’s largest economy continues operating at two speeds. On the one hand, a strong U.S. dollar and lackluster global demand are weighing on exports, while low oil prices and rising election uncertainty continue adding pressure on business investment. On the other hand, a solid labor market, rising real wages and buoyant consumer confidence are boosting household spending. Economic data for August showed that the ISM manufacturing index fell into contractionary territory for the first time in six months and nominal retail sales decreased over the previous month. The drop in retail sales mainly reflected a price effect from the fall in gasoline prices that month rather than a slowdown in consumption. In fact, consumer fundamentals remain rock solid: employers created 151,000 new jobs in August and consumer confidence rose to an 11-month high.
The U.S. economy is expected to strengthen in the second half, buoyed by solid private consumption and a bounce-back in inventories. Yet a strong U.S. dollar, weak global demand and low oil prices will continue to weigh on the country’s exports and fixed investment. Analysts expect GDP to increase 1.6% in 2016, which is down 0.1 percentage points from last month’s forecast. For 2017, our panel sees GDP growth at 2.1%.
EURO AREA | Economy navigates muddy post-Brexit vote waters
The Eurozone economy slowed in the second quarter as weakness in domestic demand outweighed a brighter external sector. Despite the downturn, many of the conditions that have driven the recovery remain intact and high frequency data for Q3 has been resilient, suggesting that a large Brexit-induced shock to growth has yet to materialize. The composite PMI remained in expansionary territory in September and economic sentiment recorded only a mild decline in August. However, post-Brexit vote optimism is still premature as the brunt of the impact will be felt over a longer horizon. The vote also has profound political complications for the European Union and leaders from the member countries—except for the UK—met in September to discuss a roadmap for the future. The talks focused on promoting growth and bolstering security within the Union but kicked more controversial topics such as migrant quotas down the road.
Risks to the Eurozone’s outlook remain fairly balanced and our panel held their forecasts unchanged this month. While slower global growth and the uncertain political environment could weigh on growth prospects, supportive monetary policy and resilient domestic dynamics are supporting the economy. Our panel sees the Eurozone economy expanding 1.5% in 2016 before decelerating slightly to 1.4% growth in 2017.
JAPAN | Fiscal and monetary policies will support growth
Stronger growth in investment due to high corporate profits and cheap borrowing prompted the economy to fare better than initially expected in Q2. GDP expanded 0.7% in Q2 over the previous quarter in seasonally adjusted annualized terms (SAAR). While the print was above the 0.2% increase reported in the first estimate, it was markedly below the 2.1% expansion in Q1. More recent data suggest that although growth will remain sluggish in the foreseeable future, the economy will benefit from a two-decade low unemployment rate and fresh spending envisaged in this year’s supplementary budget. On the downside, a strong JPY is hurting the external sector: exports contracted for the eleventh consecutive month in August.
The Central Bank’s ultra-loose monetary policy, the government’s proactive fiscal stimulus and a low unemployment rate are expected to support growth this year. However, a strong yen remains the main downside risk to growth. Overall, the lack of profound economic reforms is clouding Japan’s long-term growth prospects. Analysts see the economy growing 0.6% this year, which is up 0.1 percentage points from last month's projection. Next year, they see growth at 0.8%.
UNITED KINGDOM | Brexit vote shock gradually fades
A rebound in survey data in August following the downturn right after the EU referendum suggests that the Brexit shock on business and consumer confidence is slowly fading out. Helped by the weaker exchange rate, the manufacturing PMI hit its highest reading in August, reflecting expansion in both activity and new orders. It remains to be seen whether the sector is recovering the ground lost following the referendum or if the strong performance will continue. In August, consumer confidence recovered somewhat, on the back of accommodative monetary policy and a robust labor market, but the index still remains below its pre-Brexit level. Pressure from pro-Leave campaigners is mounting on Prime Minister Theresa May to declare the date when the UK will trigger Article 50 of the Lisbon Treaty. However, chances are high that negotiations will not start any time soon since May has ruled out the initiations of the formal negotiations this year and progress will likely be limited at least until after general elections in France in 2017.
Uncertainty stemming from the Brexit vote will continue to deter investment, but accommodative policy action taken by the BoE will soften the impact. This month, our panel upgraded the GDP forecast for the second consecutive time. The economy is expected to grow 1.6% in 2016, which is up 0.1 percentage points from last month’s estimate. For 2017, the panel projects that the economy will grow 0.5%.
INFLATION | Global inflation stabilizes at two-year high for second consecutive month
Mixed developments in the evolution of consumer prices in developed and emerging economies caused global inflation to stabilize for a second consecutive month. It remained steady at July’s 3.1% in August, according to an estimate produced by FocusEconomics. This is the highest level since August 2014 and mainly reflects a gradual increase in world food prices.
Meanwhile, low energy prices have driven 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 markets expecting the next rate rise in December.
Taking these developments into account, our panel of analysts expects global inflation to continue rising and to average 3.6% in 2016, which is up 0.1 percentage points from last month's estimate. For 2017, the panel expects global inflation to rise further to 3.8%.
Written by: Ricardo Aceves, Senior Economist