Economic outlook: slow progress
While the US is likely to lead global growth higher in 2016, risks such as disappointing Chinese expansion, even lower commodity prices and geopolitical shocks persist, says Stewart Robertson.
The start of 2016 was marked by a sharp increase in volatility in financial markets, as growth fears sparked weaker oil prices, wider credit spreads and sharply lower equity prices. While economic data has generally turned for the better recently, global growth expectations for this year have been marked down. This reflects weaker growth in both ‘developed’ and ‘emerging’-market economies. While the US is likely to lead global growth higher in 2016, risks such as disappointing Chinese expansion, even lower commodity prices and geopolitical shocks persist.
Inflation outlook subdued
Global inflationary pressures remain muted, with excess capacity and the fall in energy prices weighing on both core and headline inflation. By contrast, there is relatively little slack in the US and measures of core inflation – which exclude changes in food and energy prices from calculations – are close to their pre-crisis averages. Assuming no further decline in oil prices, headline inflation is also likely to be close to target by the end of this year. Given this backdrop, we expect the US Federal Reserve (Fed) to hike rates once or twice in 2016. Elsewhere, inflation is likely to be well below target as spare capacity is slowly eroded. Further policy stimulus from central banks in China and Japan is likely, while an extension of the European Central Bank’s (ECB) asset-purchase programme can’t be ruled out.
Looser policy combats disinflation risks
US economic expansion, which slowed towards the end of 2015 to a little below trend, was mixed in the first quarter of this year. However, the underlying drivers of growth remain in place with strong disposable income growth underpinning further gains in household consumption, while the drag from manufacturing and energy activity subsides.
Although the plunge in oil prices continues to weigh on the Canadian economy, some export sectors outside of energy have improved, supported by a weaker exchange rate and US demand. Fiscal measures introduced earlier in 2016 will help to boost growth, but further monetary policy easing may be necessary.
The pace of the euro-zone recovery remains disappointing with little sign of improvement in the region’s growth prospects. The ECB’s latest policy-easing package looks sufficient in its scale and scope to help underpin the recovery, but downside risks remain. Headline inflation is set to remain very low for much of 2016, risking a further de-anchoring of inflation expectations. Nor is the outlook for the bloc aided by the appreciation of the euro seen this year.
In Japan, the Bank of Japan (BoJ) shocked markets in January by introducing negative rates. While the yield on long-dated Japanese government bonds has fallen more than for shorter maturities as a result, the yen has strengthened on increasing concerns over global growth. That makes it increasingly difficult for the central bank to achieve their inflation target, particularly as domestic conditions have deteriorated. We expect the BoJ to ease policy again in the coming months, with further fiscal stimulus also on the cards.
While UK growth has slowed in recent quarters, it remains around trend. However, the near-term outlook is dominated by the June’s UK referendum on EU membership. While our central scenario is for current arrangements with the group to be retained, there would be significant downside risks in the event of a vote to exit. Absent that outcome, we see healthy domestic demand, continuing falls in the unemployment rate and that the risk of a rate hike is greater than the market foresees.
China to put growth first
March’s National People’s Congress appears to have prioritised Chinese growth over other objectives after attempts to rebalance output away from export-driven activity. That means more aggressive credit and fiscal stimuli to boost investment spending, pushing back the reform process. While that limits the near-term risk of a sharper slowdown and should support global growth, it will also increase the economy’s imbalances and business’ indebtedness, storing up bigger problems in the longer term. We expect only a modest depreciation in the yuan, with tighter capital controls in China this year. The country’s stimulus measures have at least helped moderate the growth slowdown elsewhere in Asia.
Meanwhile, the recent stabilisation in commodity prices, weaker US dollar and associated moderating inflation outlook offers a glimmer of hope for Latin America.
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- While global inflationary pressures are muted, the US headline rate is likely to be close to target by the end of 2016
- We expect the US Federal Reserve to hike rates at least once this year
- The pace of recovery in the euro zone remains disappointing with the outlook for the bloc not aided by recent currency appreciation
- Further policy stimulus from central banks in China and Japan is likely, and an extension of the European Central Bank’s asset-purchase programme can’t be ruled out