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Summary

US - Underlying growth is set to accelerate through 2017. The biggest unknown on the growth front remains the potential for an expansionary fiscal package in the next six months.

Eurozone - The combination of greater political stability and improved economic performance is a potent cocktail for the Eurozone.

Japan - For the first time since 2014, domestic demand, consumption and investment spending, has been contributing the lion’s share of growth.

UK - The UK economy slowed noticeably in the first half of 2017, with weaker consumer spending and business investment the main explanation.

China – full-year growth for 2017 is likely to be comfortably above the authorities’ target of 6.5 per cent.

Canada - Annual growth in the second quarter rose to 4.2 per cent, driven by consumer spending.

United States

Underlying growth is set to accelerate through 2017. Having begun the year somewhat slowly, growth rebounded in Q2 and, absent the temporary drag on growth from recent hurricanes, looks set to continue to be above trend through to the end of the year. Households remain the key driver, with continuing gains in the job market, a steady rise in real disposable income and strong balance sheets supporting growth. Business investment has also picked up in recent quarters and will be an important contributor looking ahead, supported by loose financial conditions and positive sentiment. The biggest unknown on the growth front remains the potential for an expansionary fiscal package in the next six months.

Inflation has unexpectedly softened in recent months, as a number of one-off factors pulled it down by around 0.2-0.3pp. While those factors are likely to reverse when they drop out of the year-on-year comparison in 2018, other measures of core inflation, such as the trimmed-mean have also fallen, suggesting the softening goes beyond those one-off factors. Looking ahead, we expect core inflation to start rising again steadily, with stronger import prices pushing up on goods price inflation, and service inflation rising at a similar rate to in 2015/16. We expect the Federal Reserve to raise rates once more in 2017 and two or three times in 2018.

Eurozone

The combination of greater political stability and improved economic performance is a potent cocktail for the Eurozone. Elections in the Netherlands and France have concluded successfully, with the election of Macron especially adding to momentum for closer integration within the Eurozone. The German election saw Chancellor Merkel win again, albeit with a reduced share of the vote. We see the conditions in place for more favourable progress towards closer integration.

Annual GDP growth exceeded 2 per cent for the first time since 2011, with domestic demand providing much of the impetus, a rare occurrence in Europe. Improving labour markets have been key, with falling unemployment boosting consumer sentiment and spending. Above-trend growth should continue in the rest of this year and next, although a slight moderation is to be expected – and is necessary over the longer run. The trend rate is probably no more than 1 per cent. Stronger growth is welcome for now, but it is appropriate that the ECB is considering its exit options. Stubbornly low inflation – because of spare capacity – means they are right to be cautious in their approach. We expect tapering of asset purchases soon, and modest rate hikes to follow in the second half of next year.

Japan

A large upside growth surprise for Q2 pushes up the average growth forecast for the entire 2017 possibly to above 1.5 per cent. For the first time since 2014, domestic demand, consumption and investment spending, has been contributing the lion’s share of growth. This is significant as in 2014 the growth spurt was driven more by the advent of Abenomics, while the latest surge comes in the absence of any large stimulus. Another positive development has been wages with employee compensation data suggesting that several years of labour market tightness is finally feeding into wage growth.

Meanwhile, there is little to suggest that the BoJ is any closer to achieving its 2 per cent inflation target than it has been in recent years. Yen appreciation, ongoing in real effective terms since mid-2015, is a powerful dampener on inflation and market inflation expectations, which makes any talk of an exit strategy from yield curve control look premature.

United Kingdom

The UK economy slowed noticeably in the first half of 2017, with weaker consumer spending and business investment the main explanation. The squeeze on real incomes from higher inflation has hurt households, while Brexit uncertainties have weighed on both them and businesses. Both of these headwinds to growth look set to continue for the rest of the year and into 2018, implying no meaningful pick up in growth. The Organisation for Economic Cooperation Development (OECD) now projects that the UK will be the slowest growing economy in the G7 next year. This last happened in 1991.

Surprisingly, jobs growth has held up well and unemployment has not risen which provides some offset, but weak output growth has meant falling productivity, adding to downward pressures on wages. The BoE expected weaker demand growth, but has switched emphasis to negative supply-side shocks, diplomatically avoiding putting the blame solely on Brexit. The implication is that UK rates will need to rise earlier and it would now be a surprise if they did not move in November. But if demand remains sluggish, as we expect, then further hikes may be some way off. A weak economy is more vulnerable to shocks, so Brexit negotiations are critical.

China

A significant positive growth surprise for Q2 means that fullyear growth for 2017 is likely to be comfortably above the authorities’ target of 6.5 per cent. The strong growth backdrop has meant that the authorities can continue the ongoing regulatory deleveraging targeted at the shadow banking sector. But as a result of the fading credit impulse, some growth moderation over H2 2017 is still likely. Even so, leading indicators such as the Li Keqiang index and prices of industrial metals suggest that growth momentum is likely to remain positive enough for the remainder of the year. The inventory cycle appears to be at the late-cycle restocking stage which is likely to support growth for the next few quarters or more.

The reform agenda is likely to be the central focus of the 19th Party Congress in October. It is likely that the authorities will further embrace slightly lower rates of growth to enhance the quality and sustainability of the underlying growth. Downside risks include a sharper slowdown in the housing market and, in a more extreme scenario, deleveraging induced accidents in the banking and shadow banking sectors and the related credit retrenchment to the wider economy.

For now, these risks are likely to remain reasonably well contained given the proactive calibration of policy responses by the People’s Bank of China (PBoC) and other regulatory authorities. At the same time, given the progress in rebalancing away from industry and investment towards consumption and services, the quality of growth has improved and is probably more sustainable. 

Canada

BoC has hiked twice over the last quarter, with a 25bp in both July and September, so the policy rate now stands at 1 per cent. The cumulative 50bp hike has effectively undone the 50bp of policy easing that the central bank put in place in 2015 following the fall in oil prices. In their September statement the BoC remained positive on the growth outlook, highlighting the broad-based and self-sustaining nature of the recovery. Annual growth in 2Q17 rose to 4.2 per cent driven by consumer spending, which in turn has been supported by improving employment and income growth. Investment and net trade contributions to growth have also improved while growth has been less reliant on government spending.

The housing market, which had been an area of concern for the BoC, appears to be cooling in some markets in response to recent changes in tax and housing finance policies. However continued high levels of household debt will remain in focus and are likely to temper the hawkish stance of the central bank. The BoC highlight that future monetary policy decisions are not predetermined and will be guided by incoming economic data and financial market developments. In particular they will be watching the evolution in potential growth and labour market slack. Inflation has ticked up recently but remains below the 2 per cent target, while the recent improvement in wage growth should support underlying inflationary pressures..