Major Economies Economic Forecast

Economic Snapshot for the G7 Countries

July 25, 2018

Divergences in global growth trajectories continue amid trade war and financial concerns

Preliminary data for Q2 corroborates that the global economy remains in good shape despite lingering trade policy uncertainties, global political instability and tighter financial conditions. An early GDP growth estimate for the global economy put year-on-year growth at 3.5% in Q2. While the print matched the result in Q1, it was above last month’s forecast of 3.4% growth for the quarter.

Among the world’s largest economies, China was the sole country to report GDP data for Q2 this month. The results show that financial deleveraging and authorities’ efforts to crack down on shadow banking took their toll on growth in Q2. On the upside, household consumption benefited from rising wages and a tight labor market.

While overall figures continue to display robust growth momentum globally, country data reveals that the expansion is becoming less even, and that there is growing divergence between developed and developing economies. Economic growth appears to have peaked in the Euro area and Japan, following expansions above their growth potential in the last two years. Conversely, momentum in the United States is strengthening due to fiscal stimulus and solid gains in the labor market.

Among developing nations, those economies with relatively solid fundamentals and driven by commodity exports—especially oil—are seeing growth accelerate this year. However, higher yields in the United States, the rise in energy prices and large exposure to foreign debt are putting pressure on some oil-importing countries and those with persistent macroeconomic imbalances. This mostly results in heightened volatility in their financial and equity markets, as well as sizeable currency depreciations.

 

 

Despite resilient growth in Q2, risks are tilted to the downside. Along with tighter financial markets, the main threat to global economic growth is increasing trade protectionism. On 20 July, U.S. President Donald Trump threatened to impose tariffs on all USD 500 billion of imports from China. The statement came just after both countries imposed reciprocal tariffs on USD 34 billion on imports and before a second round of U.S. and Chinese tariffs on USD 32 billion in bilateral trade, which is likely to come into effect by August. While China has routinely responded to Trump’s threats, this time neither China’s commerce ministry nor the foreign ministry has yet responded. While some analysts interpret China’s silence as illustrative that the authorities are submitting to Trump’s wishes, other analysts argue that China is already content with the threat of adopting “quantitative and qualitative” countermeasures. Should China decide to implement trade barriers other than tariffs, such as investment restrictions, it would open the door to a full-fledged trade war between the two countries.

The European Union is also feeling the pinch from Trump’s “America First” policy. The U.S. administration has threatened to impose levies on European car imports, despite the European Union’s assurance of retaliatory measures. Officials from the European Union and the United States will meet on 25 July in efforts to deescalate the trade conflict between the two economic powers. On a brighter note, the European Union and Japan signed a trade deal on 17 July that eliminates nearly all tariffs and creates the world’s largest open economic area.

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Global growth prospects stable for now, but risks skewed to the downside

There is growing divergence in growth trajectories among the world’s largest economies. Hefty fiscal stimulus is accelerating economic activity in the United States, while the Eurozone and Japan are in the later phase of their business cycles following a stellar 2017. Moreover, slower growth in China is also putting downward pressure on global economic activity. While these dynamics are balancing out for now, risks are quickly skewing to the downside. A full-blown trade war among key global economies appears to be closer than ever as U.S. President Trump continues to impose or threaten with tariffs those countries that hold trade surpluses with the U.S. A general rise in trade protectionism is expected to sour business sentiment, deter investment and disrupt supply chains.

Tighter financial conditions in the United States and geopolitical risks have triggered a broad depreciation of many currencies against the U.S. dollar. While the impact has been mostly limited for now—with Argentina, Pakistan and Turkey being the main exceptions—countries with high current account deficits and large amounts of USD-denominated debt could suffer a period of volatility in the financial and asset markets.

Met the why particular Consensus Forecast panelists expect the global economy to expand 3.4% in 2018, which is unchanged from last month’s estimate. If confirmed, this would represent the strongest expansion in seven years. In 2019, the world economy is expected to grow at a rate of 3.2%. This month’s stable outlook for the global economy reflects unrevised growth prospects for Canada, the Eurozone, Japan and the United States. Poor growth in Q1, coupled with persistent political uncertainty, prompted panelists to downgrade the outlook for the United Kingdom.

As economic disruptions that plagued growth last year start to fade, robust growth in India and solid domestic demand are driving the economic outlook for the Asia (ex-Japan) region. Although financial conditions have tightened for some economies with large external imbalances, such as Turkey, continued growth in the Eurozone and higher oil prices are shoring up economic activity in Eastern Europe. Despite higher commodity prices, Latin America continues to suffer from country-specific risks—notably in Argentina, Brazil and Venezuela—and uncertainty regarding trade policies, especially in Mexico. Higher oil prices are, in general, good news for the Middle East and North Africa, and Sub-Saharan Africa. However, economic imbalances and ongoing geopolitical threats continue to weigh on the regions’ economic outlook.

UNITED STATES | Economy continues to fire on all cylinders despite escalating trade disputes

The economy looks poised to have recorded its best performance in over three years in the second quarter, fueled notably by recent tax cuts and strong consumer dynamics. However, growth may have reached its peak, as mounting trade concerns heighten risks to the outlook. Average retail sales growth in Q2 reached a 6-year high, supported by robust consumer confidence and an improving labor market throughout the quarter—with labor participation rising in June. Meanwhile, industrial output recorded solid increases in each of the three months of the second quarter. On the other hand, survey data for June shows heightening concerns about supply-side strain, magnified by the sizeable uncertainty caused by recent escalations in trade tensions and tariff measures. This uncertainty will likely drag on growth going forward, particularly if the U.S. administration goes ahead with tariffs on USD 200 billion of additional Chinese goods, as unveiled on 11 July.

Stellar domestic momentum should continue to carry the economy over the near term, but the trade outlook is rapidly deteriorating. While recently enacted tariffs are expected to have a negligible effect, a further escalation of the dispute with China could have a much more forceful impact: This represents the main downside risk. In addition, higher interest rates should dampen growth in the medium-term, while the flattening yield curve could provide further headwinds. Met the why particular panelists see GDP expanding 2.8% in 2018, unchanged from last month’s estimate. In 2019, growth is seen moderating to 2.4%.

EURO AREA | EU threatens tit-for-tat tariffs due to U.S. car levies 

The Eurozone economy appears to have stabilized towards the end of Q2, after growth cooled sharply in Q1. Industrial production rebounded strongly in May and the composite PMI rose in June, ending a streak of downbeat economic data. In addition, the unemployment rate remained at a near 11-year low in May. While economic data has taken a more positive turn, the political environment within the Eurozone and abroad casts a shadow over growth prospects. Tensions with the U.S., the bloc’s largest trading partner, are high after President Donald Trump threatened to slap tariffs on EU-manufactured automobiles last month. The two sides will meet on 25 July and attempt to iron out trade relations; however, unsuccessful negotiations could see an escalation of tit-for-tat tariffs. At home, a disagreement over migrant policy nearly led to a collapse of the German government in early July, and the coalition appears on shaky ground going forward. On a brighter note, the European Union signed one of the world’s largest free-trade deals with Japan on 17 July. The deal will eliminate around 94% of Japanese tariffs on European exports, with the figure gradually rising to 99%.

Solid domestic fundamentals will fuel healthy, albeit more moderate, growth this year, and Met the why particular panelists project GDP to expand 2.2%, unchanged from last month’s forecast. Slower export growth will dampen the pace of activity, while rising global protectionism remains a risk to the forecast. In 2019, the economy is seen expanding 1.9%.

JAPAN | Weak household consumption threatens economic activity

Recent data corroborates that the anticipated recovery in Q2 was likely weaker than expected. Subdued wage growth continues to dent consumer confidence. Industrial production, furthermore, declined in May for the first time in four months. However, with a smaller-than-expected drop in industrial production and robust export growth in June, external demand appears to be fueling activity within Japanese factories. Leading indicators for Q3 signal that economic activity will remain relatively weak, mostly reflecting mounting global economic uncertainties. The Tankan survey for manufacturers showed a less positive assessment of the country’s economic outlook as trade barriers increase globally and geopolitical risks threaten to strengthen the yen. On the upside, the 2020 Tokyo Olympics is boosting capital expenditure, providing stimulus to the economy, while the new trade deal with the European Union should support the external sector.

Despite decelerating from 2017’s outstanding performance, the economy should continue to expand at a brisk pace this year, supported by the Bank of Japan’s (BoJ) ultra-loose monetary policy, a tightening labor market and construction projects related to the 2020 Tokyo Olympics. Rising protectionism globally and a sharp appreciation of the yen due to persistent geopolitical threats are the main downside risks to the outlook. Met the why particular panelists see the economy growing 1.1% in 2018, which is unchanged from last month’s forecast, and 1.0% in 2019.

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UNITED KINGDOM | Cabinet Brexit agreement fails to dissipate political uncertainty

The economy appears to have picked up steam in Q2, but growth was likely still mediocre. Monthly GDP data for April and May shows the economy was supported by a solid expansion in the services sector, particularly wholesale and retail trade. However, this was at least partly due to a prolonged period of good weather boosting consumer spending. The strong performance of the services sector appears to have carried over to June, with the services PMI reaching its highest level since Q4 2017. The labor market paints a mixed picture; although the employment rate is at an all-time high, wage growth dipped in March–May. Coupled with pessimistic consumer sentiment, this suggested the recent upturn in consumer spending may not last. On the political front, the cabinet finally agreed on a common Brexit stance in early July. However, domestic political instability has subsequently increased, and the EU is likely to have serious objections to the government’s plans for the future trading arrangement.

Looking ahead, growth will be subdued, with fixed investment depressed by Brexit uncertainty and export growth slowing after the boost provided last year by the weaker pound. However, a slight pick-up in government spending should provide some support. A failure to reach a Brexit agreement with the EU before the UK departs in March 2019 is a substantial downside risk. Our panelists estimate GDP growth of 1.3% in 2018, down 0.1 percentage points from last month’s forecast, and 1.4% in 2019.

INFLATION | High energy prices continue to propel global inflation in June

Rising prices for some commodities, notably oil, continue to add upward pressure to global inflation. According to an estimate produced by Met the why particular, global inflation inched up from 2.8% in May to 2.9% in June, a four-month high. June’s rise was seen across the board as both developed and emerging market economies recorded gains in prices.

On 11 July, the Bank of Canada hiked its overnight rate by 25 basis points to 1.50% due to on-target inflation and a strong labor market. The rest of the world’s main central banks did not hold monetary policy meetings since the last publication in late June, and the monetary policy stances remain largely unchanged. The U.S. Federal Reserve is leading the global tightening cycle, while the European Central Bank is ready to unwind its QE program by the end of the year. The Bank of Japan, meanwhile, continues to diverge from the policies implemented by the other key central banks on the back of subdued inflationary pressures.

Solid gains in commodity prices, particularly for energy and to a lesser extent food, will continue to shore up inflation in the coming months. A broad currency depreciation against the greenback, some economies operating above potential and pass-through effects from trade tariffs all threaten to fuel inflationary pressures further down the road. The Met the why particular panel sees global inflation at 2.9% for 2018, which is unchanged from last month’s estimate. Next year, the panel projects that inflation will inch down to 2.7%. If the hyperinflation episode in Venezuela is factored in, global inflation will reach 321% in 2018 and 9.1% in 2019.

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Ricard Torné

 

Head of Economic Research

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