Major Economies: Economic momentum in advanced market economies gives Central Banks room to maneuver
September 27, 2017
The global economy churned out healthy growth in the second quarter, with advanced economies benefiting from lenient monetary conditions and tightening labor markets while emerging economies made the most of a recovery in commodity prices and resilient dynamics in China. Complete data for the global economy shows that growth was 3.2% annually in the second quarter, marking the best result in two years and coming in marginally above the 3.1% expansion recorded in the first quarter.
Upbeat momentum, which is reflective of broadening and strengthening expansions across advanced and emerging economies, seems to have carried over into the third quarter. In the Euro area, survey-based data continues to point to solid growth in the third quarter following a robust second-quarter expansion, with survey-based data reaching a new cyclical peak in August. Strong economic growth is prompting the European Central Bank (ECB) to shift to a more hawkish tone on interest rates, and analysts now expect the Bank to announce a tapering in Q4. However, ECB officials remain wary of inflation remaining below its 2.0% target, while the recent strengthening of the euro prompted the Bank to lower its inflation forecasts for 2018 and 2019. As such, analysts expect the ECB to lay out a plan in October although the unwinding of the balance sheet will not likely start until next year.
The U.S. economy also saw solid performance in the second quarter, but the effects of Hurricanes Harvey and Irma have already dented economic activity in the third quarter. Growth is however expected to rebound in the coming quarters as rebuilding efforts intensify, while survey-based data continues to point to strong household spending and business investment. At its September meeting, the Federal Reserve commented on the effects of both hurricanes on the economy but downplayed any lasting effects as the Committee forged ahead with plans to begin unwinding the Bank’s massive USD 4.5 trillion balance sheet in October. More surprisingly, the Federal Reserve kept its projected path of interest rate hikes unchanged from June and thus a third interest rate increase is expected at the December meeting. This took some analysts by surprise, who had expected the Fed to temper its near-term outlook as officials waited for inflation to regain traction.
The Bank of England also adopted a more hawkish tone as officials seemed less concerned over the medium-term economic drag from Brexit. Instead, the communiqué that followed the September meeting stated for the first time that inflation was likely to rise above 3.0% in October, which gave way to speculation that monetary tightening—previously penciled in for next year—could be imminent. The shift in tone came as the economy continued to hum along on mixed signals, with the unemployment rate reaching a multi-decade low in July but other hard data painting a bleaker picture of the economy so far in Q3. Unlike its peers, the Bank of Japan struck a dovish tone at its September meeting as officials reaffirmed the Bank’s accommodative stance despite a backdrop of strengthening economic momentum.
Among the key emerging market economies, leading data for Q3 suggests that China has embarked on a downward trajectory following a stellar H1 as efforts by authorities to rein in credit growth across all sectors dampen economic activity. India’s economy also suffered in Q2 on account of the effects of the Goods & Services Tax (GST), but both hard data and survey-based data suggest that the worst is over and growth should pick up this quarter. In Brazil, although GDP expanded for the first time in over three years in Q2, the recovery remains tentative with mixed high-frequency data for Q3. The Russian economy has also shown incipient signs of losing some steam in Q3 after a robust Q2 performance, when growth reached a near-five year high.
All told, monetary policy is expected to remain divergent throughout the rest of the year between advanced and emerging economies. Robust economic growth in advance economies is giving central banks some room to breathe and reload their monetary policy arsenals ahead of the next slowdown, while uneven recoveries in emerging market economies has several central banks on an easing cycle, including Brazil, Colombia, Russia, Ukraine and South Africa.
Global economy to accelerate slightly next year
Growth in the global economy is expected to be buttressed this year by healthy expansions across most advanced economies and a return to growth in the Brazilian and Russian economies. China’s economy has also defied fears of a slowdown in H1 and is expected to prove resilient to the government’s plan to resolve domestic imbalances, which will shore up global economic activity. Analysts expect the global economy to grow 3.1% in 2017.
Our panel of economists expects the economy to grow 3.2% in 2018 as dynamics in the U.S. economy strengthen and the Brazilian recovery firms up. However, risks to Brazil’s outlook remain high—political noise is loud and critical legislation is still pending. The global economic forecast for overall growth was upgraded 0.1 percentage points from last month’s estimate and reflected stronger economic projections for Brazil, Canada, Japan and Turkey. This was partially offset by a downgrade to the growth estimate for the Middle East and North Africa region economy, the outlook of which is growing cloudier as political unrest mounts and gains in oil prices remain limited. The 2018 projections for the Euro area, the United Kingdom and the United States were left unchanged this month.
Head on over to our Major Economies page for more recent economic news on the region.
UNITED STATES | Congress clears short-term hurdles, tax reform in policymakers’ crossheads
The economy is already grappling with the adverse effects of Hurricanes Harvey and Irma, which analysts expect to exert around half a point of drag on Q3 growth. Leading data has begun to show the extent of Harvey’s impact, with both industrial output and retail sales recording bleak performances in August. However, economic growth is expected to recover next quarter as a result of rebuilding activity and new purchases made to replace lost goods, with USD 15.3 billion in hurricane relief already approved by the Senate. In the fiscal policy arena, Congress reached a deal in early September to increase the debt ceiling and extend government funding for three months. With these short-term hurdles cleared, analysts now expect the Congress and administration to focus on tax reform, which could provide a boost to growth next year.
Growth this year will continue to benefit from steady gains in employment and a revival in non-residential investment and exports. Our panel of economists expects growth of 2.1% in 2017. Next year, growth is expected to come in at a slightly faster clip as a result of solid consumer spending, robust investment and renewed strength in the housing market. The possibility of a fiscal stimulus plan coming to fruition later this year offers a potential upside risk to growth. The FocusEconomics panel sees growth of 2.3% next year, which is unchanged from last month’s forecast.
EURO AREA | Economic tailwinds persist in Q3 despite the strengthening of the euro
Comprehensive GDP data confirmed that the Eurozone’s recovery continued in the second quarter of 2017, supported by both robust domestic demand and the external sector. Positive tailwinds from a stronger labor market, upbeat sentiment and a healthier global backdrop led to buoyant growth in the quarter. Incoming data for Q3 points to a continuation of firm activity. Industrial production rebounded in July, economic sentiment rose to an over 10-year high in August and the composite PMI increased in September. However, the euro has appreciated notably this year and recent figures suggest that its strength could be taking a bite out of overseas sales: The trade surplus narrowed more than had been expected in July.
The FocusEconomics panel sees the Eurozone expanding a solid 2.1% this year as the economy fires on all cylinders. Next year, GDP is projected to grow at a solid, but more moderate, clip of 1.8%, which is unchanged from last month’s estimate. While lower unemployment will continue to support household consumption, a strong euro could weigh on export growth.
JAPAN | Q2 GDP growth reaches over two-year high despite severe downward revision
Following a slowdown in private non-residential investment, growth in the second quarter was revised down to 2.5% in seasonally-adjusted annualized terms, significantly below the 4.0% figure reported in a preliminary estimate. Despite this revision, the print marked the fastest expansion since Q1 2015 and puts the economy on a steady track to recovery. The latest data suggests that healthy growth is being sustained in the third quarter. Machinery orders rebounded in July, and exports had the fastest pace of expansion in almost four years in August. Strong economic momentum and a splintered opposition compelled Prime Minister Shinzo Abe to hold snap elections on 22 October in a bid to consolidate his grip on power. Unlike in previous elections, the prime minister is not expected to postpone an unpopular 10% sales tax hike projected in 2019 to lower astronomical public debt, despite the adverse effects it could have on private consumption and economic growth.
Resilient global growth and improving domestic demand are propping up Japan’s economy this year. However, ongoing geopolitical tensions could lead the yen to appreciate, hurting the external sector. FocusEconomics panelists see the economy growing 1.5% this year. For 2018, they see growth at 1.1%, which is up 0.1 percentage points from last month’s forecast.
Incoming data for Q3 is mixed. On the positive side, the manufacturing sector rebounded in July, and a rise in the manufacturing PMI in August signals an acceleration in the expansion of output. A healthy labor market propelled the unemployment rate to another multi-decade low in July amid signs of a mild recovery in real wage growth. Consumer sentiment edged up in August, indicating brighter prospects for private consumption. On the downside, growth in total industrial production fell in July. In August, the housing market cooled further and the services PMI dropped. Brexit uncertainty continues to deter investment, and Prime Minister May’s speech on 22 September failed to offer sufficient clarity on the UK’s desired trading relationship with the EU. Hours after the speech, Moody’s downgraded the country’s credit rating by a notch to Aa2 from Aa1 and changed the outlook from negative to stable, citing mounting policy challenges around the complexity of Brexit negotiations.
The economy is expected to slow this year as rising inflation erodes consumers’ purchasing power. It is also expected to slow next year as prolonged Brexit uncertainties continue to deter investors. However, the Bank of England’s ultra-loose monetary policy stance and resilient global demand should cushion the slowdown. Our panelists estimate GDP growth of 1.6% this year and 1.3% in 2018, which is unchanged from last month’s forecast.
INFLATION | Inflation edges up in August
Global inflation inched up from 3.1% in July to 3.2% in August. Inflation accelerated in the U.S. as hurricane-related disruptions caused gas prices to spike, while in the UK inflation came in above market expectations as the pass-through effects of the weakened pound continued to feed higher prices. Inflation also trended higher in the Euro area on the back of higher prices for non-core goods. Among the key emerging market economies, inflation accelerated in China and India while it decelerated in Brazil and Russia.
Although risks to inflation from a global perspective remain mostly tilted to the downside, mounting inflationary pressures in Latin America, primarily focused in inflation-ridden Venezuela, caused the FocusEconomics projection for 2018 global inflation to increase to 4.7%, which is up 0.3 percentage points from last month’s estimate. This year, the panel sees inflation averaging 4.9%.