The global macro forecast

Emerging economies still weighting global recovery

The world economy is still struggling with intense deflationary pressures. Since 2012, world GDP growth has been hovering around the 3.5% mark, well below the 5% of the pre-crisis years: while developed countries have managed to put their economies back on a sounder footing, activity in 2015 has further weakened in emerging economies. Still, in 2016, emerging growth should eventually stabilize while growth in developed countries should continue to slowly firm, especially in the euro zone and, to a lesser extent, in Japan.

 

Emerging economies: activity slowing further

Before the crisis, many emerging economies – oil producers and China – relied on advanced economies to absorb their excess saving. In the aftermath of the global financial crisis, the emerging economies were forced to adapt their “growth model”: due to the lack of borrowers in developed countries, they extensively relied on domestic credit to support demand. However, replacing their growth model – one based on cheap labour and robust external demand – with a more consumption-driven alternative is not an easy task: building financial systems able to domestically channel their huge savings or climbing the value-added ladder are two of the many hurdles that these countries have to overcome. As a result, despite accommodative policies and rapid credit growth, activity has continued to slow and, in many places, private debt sustainability is fast becoming an issue. Coupled with declining commodity prices, this has created a “perfect storm” for emerging markets. The summer turmoil on financial markets in China and the political quagmire in Brazil are a reminder that the road ahead remains bumpy for emerging countries. Although they are now back to more normal GDP growth rates, developed countries have their own issues to address (rising support for extreme political parties, massive immigration inflows, tentatively stabilizing high public debt levels, …).

 

US & UK: closer to full employment

In the United States and the United Kingdom, private sector deleveraging has made progress and – at the time of writing – their central banks are even considering increasing their interest rates. In the euro area, while the recovery is gaining momentum, the deleveraging process is not yet over and the ECB has recently hinted at an even more accommodative monetary policy.

In the United States, indeed, the recovery is well underway. Admittedly, with the rise in the dollar and weak demand in the rest of the world, external trade will be a net drag on the economy. Still, thanks to robust domestic demand, GDP growth should be close to 2.4% in 2015 and 2016. Household expenditure in particular should remain dynamic: even if access to credit is not yet fully back to normal, residential investment will remain a positive and consumers will continue to benefit from low oil prices and improving conditions on the labour market. In this regard, the recent pick-up in private hourly earnings is encouraging. With the US economy now close to full employment (the unemployment rate reached 5.0% in October and broader measures of unemployment have clearly improved over the last few months), the further acceleration in wages should support steady consumption gains and should also pave the way for a Federal Reserve lift-off in December. Nonetheless, the tone of the FOMC release is expected to remain cautious, suggesting a very moderate pace of increase in the Fed funds rate going forward.

The recovery in the United Kingdom is also well advanced, with the economy now approaching full employment. Although both countries have experienced a significant appreciation of their currency, there is a limit to what these economies can accept. A fall in the euro (against all currencies) would only modestly affect the US, but would have a more serious impact on the United Kingdom, given its close trade links with the euro area. This partly explains why the Bank of England recently trimmed its growth and inflation forecasts and hinted that interest rates were unlikely to rise as quickly as previously expected.

Euro zone and Japan: some improvement… and further easing

While, in the US and the UK, the level of activity is now well above pre-crisis highs, the euro area and Japan are still lagging. In Japan, the slowly recovering economy has clearly been hampered by the April 2014 VAT hike. In this regard, the postponement to April 2017 of the second VAT rate hike initially planned for October 2015 is good news for 2016. This should allow domestic demand to gradually pick up, all the more so since the BoJ will continue to be accommodative for a while yet. In 2016, GDP growth should be slightly above 1% as against 0.6% in 2015.

In the euro zone, the declining oil price as well as the major depreciation of the euro exchange rate have created the conditions for a more entrenched pick-up in growth. Indeed, despite the Greek and Chinese crises, confidence indicators have been resilient. Along with the decreasing unemployment rate and bottoming-out of hourly wages, household confidence has resisted and weak oil prices should again provide some support to consumption. After having been a huge drag on activity, residential investment, too, should eventually provide some support. As demand is recovering, easier lending conditions and reduced financial fragmentation will also favour an acceleration in equipment investment. On the external side, exports have so far weathered the emerging economies slowdown, but cautiousness is of the essence and the ECB will not hesitate to increase its asset purchase programme (through an increase in its duration and/or its size) and consider other tools to prevent “lowflation” … as well as an appreciation of the euro exchange rate! After 1.5% in 2015, GDP growth should be closer to 1.9% in 2016.

 

The global economy is stretched. Due to the lack of borrowers, deflationary pressures are here to stay. In this context, the capacity to absorb new shocks will remain limited. While we are getting closer to a lift-off in the US and the UK, monetary policy will stay accommodative in the euro area… and in many of the emerging economies.

The Macro Team