Schroders Chief Economist and Strategist Keith Wade expects positive outlook for the global economy in 2018, which rides on the back of strong economic performances in Asia, Europe and the US in 2017.
Leading indicators suggest global growth in 2017 has been the strongest since 2011. This is the result of unmaterialised political risks in US and Europe, improvements in global trade that has reached 5% this year benefiting emerging markets, and an upswing in corporate earnings which have been a driving force for markets in all three regions.
As such, Schroders has revised up its 2018 global growth forecast to 3.3% from a previous estimate of 3.0%. This would make 2018 the strongest year for global growth since 2011.
Keith Wade commented: “The global growth upgrade is reflected across advanced and emerging economies. In the former we have increased our US forecast for 2018 to 2.5% from 2%, and our eurozone projections to 2.3% from 2%. Japan is forecast at 1.8% (previously 1.5%), and emerging markets is forecast at 4.9% (previously 4.8%) which incorporates a slightly stronger figure for China in 2018 at 6.4%.”
The upturn in global growth has lifted sentiment and markets, but investors and central bankers remain puzzled by the behaviour of inflation.
Wade said: “The strong growth of the world economy raises the question as to whether inflation will also accelerate and bring a greater tightening of monetary policy. So far, the acceleration in activity has not triggered higher inflation, but the question is whether the “Goldilocks” combination of strong growth and low inflation can persist in 2018.”
Schroders expects 2018 inflation to be at 2.3% (revised up from 2.2%), driven by higher oil and commodity prices which is reflected in the pick-up in producer price inflation around the world in recent months.
This forecast assumes a gradual pick up in core inflation in the US after the surprising decline earlier this year. The lags from growth to inflation are long and the revival of economic activity in 2017 supports a faster pace of inflation in 2018. In this respect, next year will see a fading of the Goldilocks combination of better than expected growth and weaker than expected inflation. Cyclical forces suggest that inflation will begin to catch-up with better economic activity.
From QE to QT
Schroders expects further tightening of monetary policy by the US Federal Reserve (Fed), and with fiscal policy providing an extra boost to growth, Schroders believes there will be three rate hikes next year after an increase in rates at the December meeting.
Wade commented: “The Fed has now started balance sheet reduction, signalling the arrival of quantitative tightening. We forecast the Fed funds rate to end 2017 at 1.5% and 2018 at 2.25%. We would then expect one more rate rise in 2019 taking the policy rate to 2.5% where it peaks. Given the reduced trend rate of growth in the US, the peak in this cycle is expected to be well below that seen in previous cycles, something the Fed has been signalling through their ‘dot’ forecasts of the long run policy rate.”
“In terms of monetary policy elsewhere, we have a tighter projection for the European Central bank (ECB) in that we assume quantitative easing (QE) will end in September next year. Growth and inflation are expected to be robust enough for the central bank to call time on QE earlier than most would expect. The ECB then raises rates in 2019.”
“In Japan, we assume that QE continues, however there is a strong likelihood of a shift in policy with the Bank of Japan likely to increase its target for 10-year Japanese government bond yields. As with the ECB this will be driven by a robust economic performance and although such moves may only be modest they represent a turning point toward tighter policy, an event which will not be missed by the markets.”
Global trade to drive overall growth in 2018
Schroders has updated its scenario analysis to reflect the macro tail risks in the world economy. The recent strength of activity has raised the prospect of a boom in global trade. This would be largely driven by an increase in the trade multiplier helping to drive exports with spill overs into employment and capex. The result is stronger growth and inflation as the upswing pushes commodity prices higher. Core inflation is also likely to pick up as wages rise further as a result of tighter labour markets compared to the base.
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