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Annualised growth in the US is expected to be around 2.5 per cent in 2019H1, down from over 3 per cent a year ago. That slowdown reflects not only the waning boost from tax cuts and increased government spending, but also the weaker global backdrop and headwinds from the ongoing trade dispute with China.
Looking ahead, we expect growth to slow further over the next 18 months, with weak business spending the main driver of that, but for the US to avoid recession.
Despite the lack of domestic imbalances – household and corporate balance sheets are not stretched – the risks are tilted to the downside due to the risk of an intensification of the trade dispute with China and others. This will put little upward pressure on inflation, which remains low, and therefore makes it more likely that the Federal Reserve will ease policy rates over the rest of 2019.
Figure 1. US
Growth surprised modestly to the upside in the first quarter as resilient domestic demand continued to offset external weakness. Although forward-looking surveys have improved a little from their Q1 base, they are still only consistent with slightly below-trend growth. Moreover, the hard data is pointing clearly to a weaker Q2.
The bottom line is that euro zone growth is still weak overall, and the threat of further global trade disruption is weighing heavily on the outlook for the region. In addition, rumbling discontent in Italy has the capacity to disrupt once more. With inflation showing no sign of moving to target in the near term, the ECB has turned dovish again.
If conditions don’t improve soon, the pressure for additional stimulus will become irresistible. We expect modest gains in both growth and inflation, but this is far from certain: all the risks look to be to the downside.
Figure 2. Eurozone
The Brexit cloud still dominates the UK outlook and now has the additional dimension of a new Prime Minister who could be far more hard-line on deal-making.
The risk of a no-deal exit has risen significantly and despite protestations from the likely new camp that such an outcome would be manageable for the economy, we believe it would have a significant adverse impact.
Uncertainty will therefore continue and is likely to hold back business investment just as it has done over the last year and a half. It is also noteworthy that employment surveys have weakened as well more recently.
Until now, robust jobs growth has helped support household incomes and consumer spending growth, offsetting weaknesses elsewhere. GDP growth is likely to stall in Q2 after the inventory boost in Q1 and inflation may well dip back below 2 per cent. In this environment, Bank of England relative hawkishness looks a little odd, especially in light of the recent change in tone from other central banks.
Figure 3. UK
The impact of trade tensions has weighed on Chinese growth over the last year, culminating in the 1.4 per cent quarterly rise in GDP in Q1. This was the lowest pace of growth since Q1 2016 when there were also significant concerns about a China slowdown.
Now, as then, the Chinese authorities have responded with a combination of policy stimulus comprising lower rates, a boost to the credit impulse and fiscal loosening.
The spectre of a damaging tit-for-tat with the US looms large, but these measures do mean there is a good chance of achieving the lower end of this year’s 6.0-6.5 per cent GDP growth target. The fiscal stimulus is more geared to the local economy this time around, so positive spillovers to the rest of the world will be smaller. Re-escalation of the trade war is the dominant risk, but any signs of constructive resolution between China and the US, something that both sides claim to want, should be welcomed globally.
Figure 4. China
Continuing external headwinds and their possible transmission into weaker domestic demand raises recession concerns, although recession risk for now does not look high, given mitigating factors such as structural capex and countervailing measures for the consumption tax hike later in the year.
Despite the logistical issues involved in abandoning the tax hike, it may still not be a done deal, as tracking estimates show overall growth slowing afresh. Q1 GDP was an upside surprise, but underlying detail was weak, as growth was largely driven by inventory accumulation and imports dropping by more than exports.
Looking ahead, consumer confidence has declined sharply which might mean downside risks for consumption demand too. Meanwhile, the bar for further Bank of Japan (BoJ) policy easing remains high, although slowdown risks, persistently weak inflation and possible yen strength given Federal Reserve dovishness could change the BoJ’s stance, starting with a further strengthening of forward guidance.
Figure 5. Japan
Canadian growth continued to slow through the first half of 2019 with broad-based weakness in exports and investment. While the contribution from consumption strengthened, the downside surprise in growth has led to downward revisions to 2019 growth forecasts.
The outlook remains predominantly driven by external factors. Volatility in the oil market has held back investment while rising uncertainty and weaker global demand have subdued exports. Increased tariffs and the ongoing uncertainty around trade policies will impede global growth.
The Bank of Canada (BoC) estimates the drag on global growth has increased to 0.4 per cent by the end of 2021, amplifying a broader structural slowdown. While the growth outlook is vulnerable to external shocks, inflation remains near the 2 per cent target and surprised to the upside in May, suggesting there is less slack in the labour market than previously estimated and that price pressures are firming. This creates a dilemma for the BoC, despite accommodative policy; further disruptions to the global outlook will likely tilt them to a more dovish stance.