GLOBAL prospects remain disappointing. Growth forecasts have been downgraded further, for the world economy as a whole and for most major countries and regions.
Our forecast is that global GDP growth will be below 3% in 2016. Two major players, Russia and Brazil, are forecast to record negative growth for the second year in a row. There is now greater awareness that central banks cannot on their own deliver faster growth in the face of major structural impediments. But, notwithstanding these concerns, the equity markets have maintained the recovery that started after the nasty setbacks seen in the first six weeks of the year. Share prices are generally above their end-2015 levels and the mood is improving. When compared with their February 2016 lows, most major stock market indices have risen by about 15-17%. But investors remain anxious. Reduced economic growth could weaken company profits, and this would undermine current high levels of share prices. Fears of recession have eased but have not entirely disappeared.
There are also concerns that negative interest rates and other extreme monetary tools that are now being deployed may cause serious damage in the future, particularly bubbles, instability and eventually higher inflation. Exceptional measures may alleviate downward short term pressures on the economy, but the risks can no longer be shrugged off. Negative deposit rates can often damage bank earnings, and this could counteract the key aim of boosting lending to businesses. At present the markets are addicted to, and are being underpinned by, exceptionally low interest rates and huge injections of central bank money. This is a source of potential instability, and it is not surprising that the effectiveness of current policy methods is increasingly being challenged. Nevertheless, it is safe to assume that the major central banks will persevere with a very expansionary monetary stance in the near future.
In the US and the UK, plans for early interest rate increases are being postponed in the face of mounting global headwinds. It seems unlikely that we will see any policy tightening before the next few months. In the eurozone and Japan, where growth prospects are even weaker, the European Central Bank (ECB) and the Bank of Japan may consider additional policy easing. This may entail offering to lend to commercial banks at negative rates, i.e. paying them to borrow from the central bank. Some are even thinking about “helicopter money”, which is best described as the central bank sending a cheque to everyone in the economy. This is considered by many economists as the most extreme policy step, and ECB president Mario Draghi said that the bank had “never discussed” the subject. However the growing risks associated with negative interest rates, and the intense opposition to pushing rates further down, may persuade central banks to consider the use of “helicopter money” if further easing is deemed necessary.
The eurozone economy continues to experience low growth, weaker than in the US and the UK, with consumer price inflation remaining stuck at around zero. Our GDP growth forecasts for 2016 and 2017 have been downgraded – for the eurozone as a whole and for the region’s two largest economies, Germany & France. Although eurozone unemployment fell to 10.3% in February, the lowest rate since August 2011, it is still twice as high as in the UK & the US.
More worryingly, many tensions within the eurozone remain unresolved. There is growing “austerity fatigue” in indebted countries such as Italy, Spain, Portugal and Greece. In contrast, voters in fiscally strong countries such as Germany and Holland are worried that they may have to accept an unacceptably large burden. The flow of migrants remains a major problem, and the electoral surge of many populist parties reflects deep resentment with the political elites. The German chancellor Angela Merkel is under pressure and her popularity has sunk. After easing policy in March, the ECB has not made any changes in April. But Draghi appears determined to take further expansionary steps, in order to push eurozone inflation nearer to the ECB target of “just under 2%”. Many Germans are strongly opposed to additional easing, which they regard as a form of disguised debt relief. But Draghi appears determined to persevere with his current stance. It seems therefore most unlikely that any ECB tightening would be considered before the final months of 2017.
The US recovery remains humdrum and GDP growth has very probably slowed in the first quarter of the year. Our full-year growth forecasts have been downgraded, to 1.9% for 2016 and 2.1% for 2017. But the US economy is still expected to expand more rapidly than other major economies. The jobs market remains robust. The US economy created 215,000 new jobs in March 2016, better than expected, and the February figure was revised up slightly. The unemployment rate edged up from 4.9% to 5%, as more people joined the labour force and looked for work. The jobless rate in January and February was at its lowest level since 2008.
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But, in spite of the positive tone of the March jobs report, there is no evidence of overheating. US wage pressures are muted and inflation remains low, at just over zero. Following its “dovish” minutes published in March, the Federal Reserve is unlikely to consider raising rates before June 2016 at the earliest. The markets continue to take the view that, given the risks to growth, the Fed will be prepared to tolerate higher inflation before tightening policy.
Brexit debate intensifies
As the UK Brexit debate intensifies and becomes even more acrimonious, there are increasing concerns about the implications for the post-referendum UK political landscape. If the “Leave” camp wins, the prime minister may have to resign and, if this happens, the UK would be plunged into a highly destabilising battle for the leadership of the Conservative Party. The outcome of the June vote is still very uncertain. But, after a wobbly start, the “Remain” camp is slowly pulling ahead. An HM Treasury study highlighting the costs of leaving – coupled with warnings from the Bank of England, the IMF and President Obama– underpinned the case for staying.
As a result, sterling regained some its losses. UK inflation has edged up since last autumn rising to 0.5% in March, the highest level since December 2014, when it was also 0.5%. But political uncertainties and evidence that UK growth is slowing reinforce the arguments for the Bank of England’s Monetary Policy Committee to wait at least until the fourth quarter of 2016 at the earliest before considering a rise in interest rates.
David Kern of Kern Consulting is chief economist at the British Chambers of Commerce. He was formerly NatWest Group chief economist.