Quarterly Economic Outlook Q2 2017

The Trump “reflation trade” is being undermined by the failure of the new US administration to implement planned legislation, specifically the Affordable Care Act (Obamacare), corporate and personal tax cuts and the border adjustment tax.

Apr 23, 2017 | John Greenwood

Overview

  • Between 4 November and 1 March US equity markets rallied by 15-18%, largely in the expectation that US real GDP would accelerate and inflation would also rise, but so far there have been few signs of either. I expect only a modest upswing of growth to 2.3% in 2017 and 2.6% in 2018, a far cry from the growth of 3.5-4.0% that Mr Trump promised in his election campaign.
  • Moreover, most of the incremental growth in 2017 and 2018 will come not from the signature Trump proposals of fiscal stimulus, such as tax cuts or infrastructure spending, but from the strengthening business cycle upswing which President Trump has had the good fortune to inherit.
  • US consumer price inflation may rise moderately but will not be much affected by the fiscal deficit. Unless money and credit growth accelerate, inflation will remain broadly unchanged, around 2%. In February the index for core personal consumption expenditure (PCE) was up 1.75%, while core CPI was 2.2% year-on-year.
  • Following the 0.25% hike in the US federal funds rate in March, I expect the US Federal Reserve (Fed) will raise interest rates twice more in 2017, taking the target range to 1.25-1.50% by yearend 2017.
  • In the Euro-area the near term environment has been and will be dominated by politics – the Italian referendum last December, the Dutch election held in March, the French Presidential election in April/May, and the German election in September - all against the backdrop of extended negotiations over Brexit.
  • The economic outlook for the Euro-area remains subdued in the short term, and still far from robust in the long term. Real GDP growth remains steady at around 1.5- 1.7%, and although headline inflation temporarily increased to 2% in February, it is likely to fall back over the coming months. Core inflation remains at 0.9%, about half of the target rate.
  • The European Central Bank (ECB) has reiterated that a shift to tighter policy is not imminent. From April 2017 asset purchases are scheduled to continue at a reduced rate of €60 billion per month, at least until December 2017. Sadly, however, the ECB’s choice of quantitative easing (QE) strategy is failing to boost the purchasing power of households and companies.
  • The triggering of Article 50 on 29 March for Brexit will lead to protracted negotiations between Britain and the European Union (EU) over the next two years.
  • During that period I expect any progress or setbacks in the discussions to be directly reflected in sterling, which will inevitably be volatile.
  • Imported inflation from the depreciation of sterling will reduce UK consumer spending in real terms, while the overall uncertainty about the exit terms will undermine foreign direct investment (FDI) in the country. However, UK exporters are starting to benefit from weaker sterling and the government is beginning to concede that a free trade option could be more beneficial than EU membership.
  • Meantime, the Bank of England’s (BoE) credit promotion policies implemented in August, risk adding domestically generated inflation to imported inflation from weak sterling.
  • The Japanese economy and Japan’s companies benefitted from mild yen depreciation in November/December following the US presidential election, but domestic consumption and investment remain lacklustre, and are not likely to accelerate during 2017.
  • China remains an enigma. On the one hand rapid credit growth has slowed and interest rates have risen a little, but in a variety of individual markets the authorities continue to apply stimulus measures. At the same time, overcapacity in basic industries such as coal and steel, and rising non-performing loans in the banking system are constraining the growth of new investment.
  • On the external side China has been grappling with capital outflows that have outweighed the current account surplus, causing the currency to weaken. However, tighter controls on capital outflows and rising domestic interest rates are slowing the outflow.
  • Despite the upswing in oil and certain metal prices over the past year, the anaemic recovery in developed economies and the necessary debt work-out in a number of emerging economies imply that the upside for commodities in 2017 is limited.
  • Finally, the recovery in the US, although already seven and a half years old, is not likely to end any time soon. Banks are repaired and creating credit; businesses and households are in good financial shape; and inflation is low. Contrary to some forecasters, I expect the current US expansion to continue for several years more.
  • China remains an enigma. On the one hand rapid credit growth has slowed and interest rates have risen a little, but in a variety of individual markets the authorities continue to apply stimulus measures. At the same time, overcapacity in basic industries such as coal and steel, and rising non-performing loans in the banking system are constraining the growth of new investment.
  • On the external side China has been grappling with capital outflows that have outweighed the current account surplus, causing the currency to weaken. However, tighter controls on capital outflows and rising domestic interest rates are slowing the outflow.
  • Despite the upswing in oil and certain metal prices over the past year, the anaemic recovery in developed economies and the necessary debt work-out in a number of emerging economies imply that the upside for commodities in 2017 is limited.
  • Finally, the recovery in the US, although already seven and a half years old, is not likely to end any time soon. Banks are repaired and creating credit; businesses and households are in good financial shape; and inflation is low. Contrary to some forecasters, I expect the current US expansion to continue for several years more.

Click Download PDF to read John Greenwood's latest outlook