Global economy improves, yet monetary policy remains accommodative
Economic Quarterly Report
- We expect global economic growth to accelerate slightly this year and next year in comparison to last year, to 3.5 and 3.6 per cent respectively
- The acceleration in 2017 will be broad-based. Growth is accelerating in both developed and emerging markets, with India and the UK as the major exceptions
- Growth in the emerging world will accelerate in 2018, with the exception of China, while growth in developed markets will generally stabilise
- The central banks in the US, the eurozone and Japan are wrestling with continuing low wage growth and low inflation. The central bank in the UK on the other hand is facing high inflation at a time of low economic growth. These dilemmas are complicating the desired normalisation of extraordinarily accommodative global monetary policy
- While political calm has apparently returned in Europe, geopolitical tensions between North Korea, the US and China are rapidly ramping up. Currently, we expect the conflict to have limited implications for the real global economy, but it does increase the risk of a trade war between China and the US
Global economic growth is picking up
Last month marked the tenth anniversary of the global financial crisis. It was on 9 August 2007 - 13 months before the notorious collapse of Lehman Brothers - that BNP Paribas froze three of its funds and thus instigated the financial crisis. Global economic growth then fell sharply and crashed in 2009. Since then, the global economy has grown at a rate of approximately 3.5 per cent. This is relatively modest in comparison to the average growth of 5 per cent seen in the years before the crisis (figure 1). Looking ahead, we are not expecting growth to return to 5 per cent in the coming years, although it will pick up to some extent. We see growth of 3.5 per cent this year and 3.6 per cent in 2018 (table 1).
Acceleration of global growth in 2017 is broad-based
Economies around the world have performed better than expected in the first half of 2017. We have accordingly slightly upgraded our growth estimate for the global economy in 2017. Global economic growth is expected to be higher in 2017 than it was in 2016. Growth is stronger in both the emerging and the developed world due to stronger internal dynamics and higher growth of exports. The major exceptions concern China, the UK and India.
China experiences a stabilisation of growth, while growth is falling in the UK and India. In China, the government is engaged in a balancing act between reining in the growth of credit and keeping the economy strong enough to safeguard financial and social stability. In India, the government took a decision to withdraw much used rupee notes from circulation. The intention of the measure was to remove black money from the economy. The consequence has however been that there is much less cash available. Since the Indian economy depends to a large extent on cash transactions, in the short term the measure has had a negative effect on domestic consumption. The UK is facing the consequences of the Brexit vote on the exchange rate and confidence. While the depreciation of the pound is good for exports, it undermines the purchasing power of households and businesses. Loss of purchasing power and low consumer and producer confidence are negatively affecting growth in both consumption and investment.
We expect global economic growth to more or less stabilise in 2018. Growth will accelerate in most emerging markets, but it will decline in China. Growth will broadly stabilise in the developed world (table 1).
Economic impact of tension over North Korea will be limited
The downside risks to the outlook appear to have eased. President Trump has effectively taken little action with respect to measures to limit trade (Erken et. al, 2017). His threats have thus become less credible. In addition, political calm has returned to Europe, at least for now. In addition, consumers and producers have apparently been little affected by the political and economic uncertainties in the past year. We expect this disregard for political and other uncertainties to continue. In our view, the geopolitical tensions between North Korea, the US and China are no exception.
Furthermore, North Korea has little economic significance, so that sanctions against that country will have virtually no direct implications for the global economy. The tensions will lead to a flight of capital from the region to safe havens such as Japan, resulting in currency fluctuations. In our view, the main risk is the possibility of a trade war between China and the US. This could happen if the US decides to punish China for - in its opinion - failing to impose adequate sanctions against North Korea, prompting retaliation from China. At this point we do not think things will go that far, just as we do not expect any military action (for more info see Rabobank, 2017). But we are watching developments closely.
Global economy does not appear to be ready for normalisation of monetary policy
As a result of the cyclical upturn, there would appear to be room for tapering monetary easing or even tightening monetary policy after years of extraordinary monetary accommodation (figure 2). The central banks in the large developed economies are however struggling with the absence of higher inflation. Inflation pressure in the eurozone and Japan has lagged the economic recovery and in the US as well, inflation is subsiding again after a brief upsurge. The underlying low growth of wages is driven by various factors such as hidden unemployment, the movement of employment to sectors with lower productivity growth, welfare cuts and the ageing of the population. In Japan, it could be that habituation to low inflation is the reason for the absence of higher price increases. (See also Rabobank, 2017 for our analysis of the reasons for low inflation in the eurozone.)
The Federal Reserve (Fed) has raised interest rates four times since December 2015. We do not expect the fifth increase to happen until next year. We do expect the Fed to announce that it will reduce its balance sheet this autumn and gradually remove liquidity from the market. The ECB is likely to announce this autumn that it will reduce its purchases of government and other bonds in the course of 2018, which should lead to stabilisation of its balance sheet volume in mid-2018. The earliest likelihood of an interest-rate hike would be in 2019. But implementation in both the US and the eurozone could be postponed by disappointing inflation. In any case, it looks as though the path to normalisation will be a long one. In Japan, the target of 2 per cent inflation is so far out of sight that the central bank has not given any hint at all regarding the reduction of its balance sheet.
The Bank of England has precisely the opposite problem: inflation is rising due to the depreciation of the pound while as stated above economic growth is under pressure. In the UK therefore it is poor economic growth rather than inflation that is preventing the central bank from tightening. The Bank of England may however feel it has to raise interest rates if the pound falls further.
So each of the central banks are wrestling with their own particular dilemmas. Moreover, especially the ECB is likely aware that its actions will have an effect on the interest costs of high levels of public and private debt. Add to this the fact that a decision by one central bank will have consequences for the economy and (import) inflation in other countries (among other things as a result of currency effects) and it is obvious that policymakers have some complicated dilemmas to resolve. They are also not helped by geopolitical squabbles such as those between the US, North Korea and China. The resulting uncertainty leads to capital flows into safe havens, which in turn affect exchange rates and therefore inflation expectations. This complex interplay contributes to the central banks taking extreme caution when it comes to policy normalisation.
Slow normalisation of monetary policy slows economic growth in the long term
So in the developed world, we see little risk of monetary tightening that could harm economic growth in the short term. The emerging markets are also benefiting from the slow path to policy normalisation in the developed world, since the huge amount of liquidity worldwide means they can borrow on the financial markets at relatively low cost. In the eurozone, we do expect the tapering of the ECB’s buying programme in 2018 to lead to increased price differentials between bonds issued by the various Member States. Euro countries with very high levels of public debt, such as Italy and Portugal, will feel this in their wallets. Generally however, the funding of high European private and public debt burdens will in our opinion be affected by monetary policy only to a limited extent. Capital market interest rates in most countries are likely to show only a limited increase in the coming two years. At the same time, the incentive to deal with these high debts and implement reforms to increase growth will also be limited, so that they will continue to weigh on economic potential for a long time.
In the longer term, with no change in policy the already known risks of extreme liquidity in the markets remain: capital will not be used where it can best contribute to increased productivity, but will rather go (in the short term) where it will generate the most return. This will lead to disturbances in financial markets and sub-optimal economic growth. Or, lower economic growth than could have been achieved with optimal use of capital. Economic growth has many fathers and also mothers. It would be wrong to blame the central banks for the years of moderate global growth. Governments should have done more to accelerate the economic recovery and thereby mitigate the need for the central banks to intervene so aggressively. The fact remains that in order to take global growth from its current mild recovery to a higher and more sustainable level, it would be helpful if the large central banks find the way to a well-measured normalisation of monetary policy.