Economic and Strategy Viewpoint
In this month's Viewpoint we update our global growth forecasts, look at Europe which has become a source of comfort in an uncertain world, and ask whether emerging markets have reached their nadir?
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- We have trimmed our global growth forecast to 2.4% for 2016. The inflation forecast for 2016 has also been reduced for the advanced economies but emerging market inflation is higher. For 2017, our forecasts are little changed, with growth strengthening modestly as a result of more stable emerging market activity. Monetary policy is easier than in our previous forecast and we now expect the next rate hike from the Federal Reserve in June.
- We continue to believe that the US will avoid a recession. Nonetheless, we recognise that our growth and inflation forecasts have been steadily drifting in a deflationary direction over the past year. Central banks can and will do more, but they are currently firing blanks, increasing the need for government action.
- Despite rising recession fears in the US and ongoing concerns over the emerging markets, Europe continues to generate solid and steady growth. Our forecast for GDP growth is largely unchanged, but the inflation forecast has been lowered due to lower energy prices. The European Central Bank is likely to respond with deeper negative interest rates for deposits.
- There have been some downward revisions to our emerging markets forecasts, but no change to our outlook for China or India, with a slowdown still expected in the former. Oil continues to weigh on Russia, and Brazil’s car crash continues.
Global forecast update: downward drift in growth, inflation and rates
We have trimmed our forecast for global growth to 2.4% for 2016 (previously 2.6%) as a result of modest downgrades to the advanced and emerging markets (EM).
The inflation forecast for 2016 has also been reduced for the advanced economies to reflect the lower oil price profile. Emerging market inflation is, however, higher largely a result of currency depreciation and administered price hikes.
For 2017, our forecasts are little changed, with growth strengthening modestly largely as a result of more stable activity in the emerging markets.
Monetary policy is easier than in our previous forecast. Although we are not forecasting a recession in the US, we now expect the next rate rise in June as weaker global growth and the recent tightening of financial conditions cause the Federal Reserve (Fed) to delay in March.
The Bank of Japan (BoJ) is expected to cut rates further to -0.25% by the end of 2016 and -0.5% by end-2017. We discuss monetary policy in Europe and China below.
A worrisome drift in the outlook
So growth continues, but our forecasts have drifted toward a world of weaker growth, lower inflation and easier monetary policy. Nonetheless, the longer run outlook remains difficult; underlying growth is weak making the world economy more vulnerable to shocks at a time when monetary policy has become impotent.
The decision by the BoJ at the end of January to take interest rates into negative territory seems to have crystallised these fears with the fall in bank stocks indicating that such a move could well be counterproductive. Central banks can and will do more, but they are firing blanks. Clearly, governments now need to respond.
Our view would be to use fiscal policy, but despite the evidence, we are not optimistic that the politicians are ready, despite the public exhortations, to join the battle.
We are not changing our scenarios this quarter, as we believe they still capture the risks facing the world economy. The balance of probabilities remains skewed in a deflationary direction.
It is encouraging that the risk of a deflationary outcome relative to the baseline has not increased in our view, but it remains high and, as discussed above, remains a concern given the low level of interest rates and perception that monetary policy cannot deliver a durable boost to growth.
Should we have a deflationary shock, there will be doubts about the ability of the central banks to dig us out of the hole and the call for government action would become deafening.
Europe: Source of comfort in an uncertain world
Despite growing concerns over the health of the US economy and ongoing fears over China and the wider emerging markets, Europe continues to generate solid and steady growth with acceptably low political risk. Who would have thought Europe would be a source of comfort for global investors?
Eurozone forecast: small downgrades…again
Our latest forecast update has a slight downgrade for eurozone growth, but most of the changes are caused by base effects rather than any fundamental change in views.
The forecast for 2016 GDP growth has been revised down from 1.5% to 1.4%, but the forecast for 2017 remains unchanged at 1.6%. We now expect inflation of 0.7% for 2016 (previously 1.3%) owing to lower global oil prices.
For 2017, the inflation forecast for 2017 stays at 1.6%. We expect the ECB to lower the deposit interest rate from its current level of -0.3% to -0.4% in March.
The authorities believe that as there are few signs that banks have passed the costs from the negative deposit rate on to households, there is scope to cut the deposit rate further. Note, we also forecast a further 10bps cut later in the year.
UK forecast: inflation challenges muddy the water for rates
The quarterly profile for our UK growth forecast has been revised up slightly as households will see their disposable income go further in real terms due to lower inflation from lower energy prices. The forecast for 2016 GDP growth remains unchanged at 1.9%, and 1.6% for 2017.
The inflation forecast is far more interesting. On the one hand, there are additional downside risks from lower food and energy prices. On the other hand, upside risks have appeared from the recent Brexit-induced sharp depreciation in sterling. Overall, our UK CPI forecast has been lowered from 1.3% to 0.8% for 2016, and from 2.2% to 2% for 2017.
We no longer expect an interest rate hike in August, because our inflation forecast no longer has the headline rate rising above 1% (the Bank of England’s lower threshold of its central 2% target) in the spring. We expect this to happen in summer instead. We still anticipate that rates will rise in November and February (2017).
Emerging markets: nadir reached?
We continue to expect a slowdown this year with GDP at 6.3% in 2016 and 6.2% in 2017. We make no change to our inflation numbers given the combination of limited pass-through to the economy from lower oil prices and further depreciation in the yuan.
Inflation is forecast at 1.9% in 2016 and 2.1% in 2017. The 50bps cut to the reserve requirement ratio on 29 February will likely be followed by a further 200bps of cuts this year, alongside interest rate cuts.
GDP is expected to fall by 2.8% in 2016. It is too soon to call a turning point, but we do expect positive growth in 2017, and think that at some point this year the worst will be over for Brazil's economy.
Meanwhile, lagged pass-through from currency depreciation will keep inflation elevated for some time. Despite this, the central bank has recently become more dovish and we expect no change in rates this year. We see the potential for easing in 2017.
While India’s Q4 GDP figures confirmed India’s place as the fastest growing major economy, the quality of both growth and data are in question. Based on a composite of higher frequency data we believe growth in GDP to have been closer to 5-6% than the 7.3% reported.
Our forecasts haven’t changed though, and we still see growth at 7.5% in 2016 and 7.9% in 2017. Inflation remains low in India, compared to historical averages, as the country continues to benefit from low commodity prices. Our base case is for rates to remain on hold throughout 2016, being cut only in 2017.
Further falls in the oil price means we have had to reduce our growth expectations for Russia to -0.7% in 2016 (from -0.2%). We expect a return to weakly positive growth in 2017, as we think the worst of the oil shock is over and the economy is showing some signs of having "bottomed out".
Our inflation forecast has been raised to 8% in 2016 (from 7.1%) as lower oil prices feed through into a weaker currency and exert upward pressure on inflation. We think there will be space for rate cuts this year.