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Strong underlying growth dynamics alongside the personal and business tax cuts early in the year, saw growth accelerate to over three per cent annualised, leaving the US as the standout economy in 2018. We expect growth to moderate somewhat in 2019, although to remain above potential, leading to a further decline in the unemployment rate.
Inflation also picked up in 2018, as the labour market tightened further, and while headline inflation is expected to be lower in 2019 due to weaker oil prices, core inflation is expected to remain around two per cent. As such we expect the Federal Reserve to continue raising rates in 2019, with three more hikes over the course of the year.
After the boom-like conditions of 2017, this year has seen growth disappointments across the Eurozone. Although there are always worries with such momentum shifts, the slowdown to a more sustainable pace (1.5 per cent annualised is still probably above trend) is appropriate given the tightness in the labour market that has resulted in a modest, but clear-cut, tick up in wage growth.
The boost to headline inflation from energy prices will reverse in coming months, pushing it back below two per cent. The hope now is that core inflation will follow wages and finally move up towards 1.5 per cent. If the two converge anywhere near that level in 2019, the ECB will be delighted. The recent tiff between Italy’s coalition government and the European Commission has once again drawn attention to political risks in Europe, although the latest developments suggest a resolution can be reached. Overall the ECB remains on track to raise policy interest rates for the first time in September or October next year.
The UK’s economic prospects have to be regarded through the lens of Brexit, something that is likely to continue to be the case for many more months and probably well past the projected leaving date of 29th March 2019.
Both consumer spending and investment have slowed significantly over the last two years, while external demand has not provided any meaningful offset. Business investment actually fell in each of the first three quarters of 2018, as UK corporations understandably held back on such expenditures largely because of Brexit-related uncertainty.
Meanwhile, although wage growth has picked up slightly as unemployment has dropped, jobs growth has now slowed to a trickle. Growth may be a little better in 2019, but that is far from certain. Inflation has continued to fall gently, although the Bank of England expects it to remain above target throughout the year. If that does not happen and Brexit concerns linger, it will be difficult for them to raise UK interest rates significantly.
China’s slowdown toward six per cent growth in coming years is continuing after an effort to curb increased leverage and the imposition of tariffs by the US and retaliation by China.
Following the G20, tariffs will remain at ten per cent for the time being, but a rise to 25 per cent on US$200bn of imports is still a possibility; policymakers are now focused on stabilisation, with most measures targeting domestic consumption.
Further credit and fiscal measures are expected in 2019, but the effectiveness of monetary measures in a system increasingly clogged with debt is uncertain. What seems certain is continued challenges, both at home and abroad. The current account surplus is gone, but a devaluation comes with increased risks. Reform and liberalization of the more closed parts of the economy cause instability and conflicts with ideological goals, while efforts to gain economic, military, and technological power conflict with US interests and the geopolitical status quo.
The natural-disasters related Q3 slowdown is likely to pave the way for a growth recovery in the coming months as disaster-relief policy measures kick in and consumer demand benefits from a front-loading of purchases before the consumption tax hike in October 2019.
Labour shortages could mean that capex continues to grow next year as firms substitute labour with capital, notwithstanding the sharp slowdown seen during Q3. However, the external environment remains a source of uncertainty despite a temporary thaw in the US-China trade tensions.
Meanwhile, moderate wage growth and subdued core inflation do not point to any major shift in the BoJ policy, although greater concerns about financial stability risks mean that minor policy tweaks may come in the coming months. The fact that the July 2018 policy tweak did not lead to any disinflationary yen strength may embolden the BoJ to pursue a balanced path between price stability and financial stability.
The new USMCA trade deal will provide businesses with a significant period of certainty and help support business investment going forward.
Growth has slowed from the strong pace seen in 2017 yet it remains above potential and has been underpinned by strong domestic conditions. As we move into 2019, growth is expected to moderate further with the composition of demand shifting towards non-oil/gas business investment and exports and away from consumption and housing. With the economy operating above potential and a tight labour market, wage growth is forecast to rise and inflation is expected to remain near target.
Against this backdrop the Bank of Canada have hiked 3 times this year and are expected to continue hiking through 2019. However, there are an increasing number of risks in the outlook that could change that policy path. The primary domestic risk is the level of household debt which has long been a concern in Canada. The sensitivity of the economy to rate rises may be higher than expected. External risks include the trade war between the US and China and a sustained fall in oil prices.
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