Quarterly Economic Outlook Q4 2017

The global business cycle expansion is still intact, supported by continuing growth in the US, joined now by a gathering upturn in the Eurozone and
the start of a renewed upswing in global trade. 

Oct 23, 2017 | John Greenwood

Overview

  • The US business cycle expansion is continuing, as reflected in rising employment, moderate real GDP growth, and rising equity and real estate prices. With inflation below target there are good prospects of this expansion achieving a record length.
  • The main risk to this scenario is that the Federal Reserve tightens credit too sharply, not so much by raising rates, but by curtailing credit growth in the private sector. Already private sector credit growth is as low as 3-4% p.a. When the Fed starts shrinking its balance sheet by as much as $50 billion per month in late 2018, private credit markets could face a challenge in absorbing this volume of Treasury and agency securities.
  • In the Eurozone economic activity is at last expanding at a momentum close to the economy’s potential. This is largely a result of the asset purchase programme started by the European Central Bank (ECB) in March 2015, and the associated acceleration of M3. To ensure momentum is sustained, commercial banks need to create credit more rapidly than at present, otherwise when the ECB starts to taper its purchases, credit growth could weaken substantially.
  • Inflation in the single currency area remains below target, reflecting the slow growth of nominal aggregate demand. Following the recent strength of the euro it seems likely that inflation will remain below target for much of 2018.
  • With the German election completed and Mrs Merkel now working to create a new coalition between her Christian Democrats (CDU), the Free Democratic Party (FDP) and the Greens, the next big event on the European calendar is the Italian election next year.
  • In Britain the growth of the economy has slowed as a consequence of the weaker pound raising inflation and eroding real wages. In addition, there has been some slowdown of investment and capital inflows, but export order books are buoyant.
  • In addition to imported inflation there is a danger that accelerating money and credit expansion in the UK could add locally generated inflation to the imported inflation. For this reason it is highly likely that the Bank of England will raise rates in November. Beyond that growth is likely to settle at around 1.5% until the uncertainties of the Brexit negotiations are overcome.
  • The Japanese economy has seen slightly better growth in 2017, but inflation remains well below 2%, despite the implementation of a massive Quantitative Easing (QE) programme from the Bank of Japan ever since March 2013.
  • To strengthen his hand in dealing with the North Korean threat and to boost spending on education and child care Prime Minister Abe has called a general election for October 22. Although he started with a strong lead, the election could prove risky for Mr Abe, particularly due to opposition from the charismatic Tokyo governor, Mrs Yuriko Koike.
  • China has continued to alternate between squeezing and easing credit with the aim of keeping the economy on the rails ahead of the autumn congress of the Chinese Communist Party. However, no great change – either in SOE reform or in monetary policy – will follow from confirming President Xi at the congress.
  • On the external side the restrictions on capital outflows and the encouragement of more inflows have enabled the currency to stabilise in recent months.
  • Improved performance of the leading economies and some upturn in the emerging economies have resulted in a mild increase in world trade. This in turn has led to some improvement in commodity prices, but not enough to translate into a commodity boom. Aside from some individual commodities responding to sector specific measures, such as trade sanctions or capacity cutbacks in China, the upside for commodities in 2017and 2018 is distinctly limited.

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