15 January 2018

The threats to the global recovery are economic – not political

By Ian Stewart

The global economy enters 2018 with good momentum. Expectations for growth this year are rising in many countries, equities are hitting new highs and business confidence is buoyant.

The worries around Brexit, the US elections, risks in the Chinese economy and populism in Europe that loomed large 12-18 months ago have eased. Our “worry index”, which tracks references to terms such as risk, uncertainty and instability in the major business papers has fallen by 30 per cent from its 2016 peak.  Financial measures of risk have declined, so much so that some see markets as overly complacent.

Last week’s surge in the oil price, to a three-year high of $70, fits with the idea of gathering global demand. A pickup in global trade has pushed up the benchmark index of sea freight rates by 50 per cent in the space of a year.

This looks like that rare thing: a synchronised global recovery, across developed and emerging countries that is delivering lower unemployment. In much of the rich world, including the US, Germany, Japan, and the UK, jobless rates are close to, or lower, than at any time in at least 25 years.

The turnaround has been particularly pronounced in two regions which have suffered persistently weak growth in recent years. Japan and the euro area saw unexpectedly strong recoveries in 2017. Both economies
should post rates of growth this year at or around the levels see last year. For the euro area 2017 and 2018 seem likely to be the best two year period for growth in 11 years.

America’s recovery has unfolded in line with earlier expectations, confounding the fears of Trump sceptics and dashing hopes of an immediate “Trump boost”. The upswing was already underway at time of the presidential election in late 2016, and has sped up since last spring. Buoyant business and consumer confidence and still-easy credit conditions point to a further acceleration in US growth this year. Tax cuts for consumers and business should bolster the growth. The Federal Reserve will continue to lead the world in tightening monetary policy. Markets are assuming that US interest rates will rose at least a further 75bp this year, taking them to 2.25 per cent.

Among emerging market countries Latin America, the Middle East and Africa look set to see the most marked acceleration in activity this year. In Asia, the world’s fastest growing region, the pace of activity is likely to remain broadly constant, with a continued, long term deceleration of Chinese growth offset by faster activity in India. India is likely to be the world’s fastest growing economy in 2018, with growth around the 7.5 per cent mark, with China and the Philippines in joint second place with growth of around 6.5 per cent. Thus, getting on for 40 per cent of the world’s population live in countries which are expected to grow by at least 6.0 per cent this year.

While worries about growth have reduced and growth has accelerated in much of the world the reverse has been the case in the UK. Brexit-related uncertainty has weighed on business confidence and spending while a weaker pound, by pushing up inflation, has hit consumer spending.

Although the pace of growth has slowed I would not overdo the gloom about the UK. In contrast to the euro debt crisis, which triggered a euro recession in 2013-14, Brexit has caused a slowdown in UK activity, from 2.2 per cent in 2016, 1.8 per cent in 2017 and perhaps 1.6 per cent in 2018. Unemployment has continued to decline, with the jobless rate now at the lowest level since 1975. Sterling weakness, while bad news for consumers, has been a boon for exporters who are also benefiting from stronger global demand. An expected easing of inflation this year, and a modest pickup in wage growth, should mean that this year is a slightly better for real incomes than last.

There are two caveats to this generally bright picture for the global economy.

The first is that growth rates remain below the levels seen before the financial crisis. This partly reflects slower growth in – and in some countries, a contraction -of the workforce as populations age. Weakness in global trade, a more deflationary environment and poor productivity growth have also weighed heavily on activity. The trade picture has improved but to turn more optimistic on long term growth we’d need more signs of improvement in these areas. An early sign would come in the form of growth in investment and wages.

The second caveat relates to risks. Financial markets are in ebullient form and seem to shrug off any bad news. Yet political risks, be it the rise of populist political parties or the threat from North Korea, Iran or from EU fragmentation, have not gone away. To achieve a smooth exit from the EU in March 2019 the UK will need to strike a deal with the EU by this October. Beyond that lies further negotiations which, in relation to trade with the EU, could stretch well into the 2020s.

But for my money the main risks to the global recovery are economic. Protectionism remains a potent threat. The Trump administration remains sceptical about the current global trading order. The renegotiation of the North American Free Trade Agreement and trade relations with China provide obvious flashpoints. Meanwhile tighter monetary policy could inadvertently knock equity and debt markets and trigger an economic downturn. That is how many post-war recoveries have come to an end. Levels of debt in many countries are high and consumers and corporates have got used to cheap money. It may not feel like it, but the recovery is mature and at a stage when growth normally peters out (America’s recovery is into its ninth year and is the third longest in US history).

The general view among economists and policymakers is that 2018 will be a rather better year for global growth. It’s a view I share. Still, we will be keeping a close eye on how markets react to tighter monetary policy. And we’ll be watching for signs that the Trump administration is putting its protectionist rhetoric into action. The big nice surprise for the world economy this year would be a recovery not just in growth, but in wages, investment and productivity too.

Taken from Ian Stewart’s Monday briefing. Sign up for the full version here.

Ian Stewart is Deloitte’s Chief Economist in the UK