Perspective - Managers' views

How trade tensions are rocking the wobbly world economy

The trade tensions are taking a toll on the outlook for the world economy.

04/10/2019

Keith Wade

Keith Wade

Chief Economist & Strategist

The trade tensions are taking a toll on the outlook for the world economy. We now expect global growth of 2.6% this year and 2.4% next (previous forecasts were 2.8% and 2.6% respectively). If the forecast is realised, global growth in 2020 would be similar to 2008, just before the great recession of 2009.

The Chinese and wider Asian supply chain will be most affected, but US activity will also suffer and we have cut our US growth forecast from 2.6% to 2.1% this year and from 1.5% to 1.3% next.

What’s the president’s plan?

From this perspective the question is, why has President Trump chosen to pursue confrontation rather than co-operation with China? Is there a plan? Our original assumption was that it would be more rational, given the upcoming election year, to strike a deal and get the benefits of lower tariffs and a recovery in growth.

Going forward it is difficult to identify the US president's strategy. It is possible that he expects China to simply back down, or that he really believes that tariffs will be good for US workers whose jobs will be protected from competition.

What will the impact be on interest rates?

The danger is that activity weakens considerably and inflation picks up as households are faced with more expensive goods such as electronics as a result of the tariffs.

Although higher inflation is usually met with higher interest rates, we expect the Federal Reserve to lower interest rates in December this year in response to the weaker growth environment.

We also see lower interest rates elsewhere. We now expect the European Central Bank (ECB) to cut rates in December 2019, but we do not expect the Bank of England to raise rates until late in 2020 and only then on the contentious assumption that the UK achieves a Brexit deal with a transition period. In Asia, China government spending is expected to increase this year and next year we expect more interest rate cuts. Although the Bank of Japan (BoJ) recently kept monetary policy unchanged, we are still expecting an interest rate cut by the end of the year.

Recent yen weakness a boon for BoJ

The BoJ’s two main concerns in need of tackling are downside risks to the external outlook and currency appreciation. It will be breathing a sigh of relief that the Japanese yen has weakened versus the dollar in recent weeks. While the central bank’s recent lack of policy action partly reflects this, it also partly reflects its lack of policy ammunition, given interest rates are already negative alongside a full-blown asset purchase programme.

However, taking a step back, these risks remain elevated. The BoJ will be reluctant to loosen monetary policy further, given the detrimental impact on the financial system, but we expect further easing measures by the end of the year.

We continue to expect a cut in the short-term policy rate from -0.1% to -0.3% in December as well as an increase in asset purchases. This should double-up as a domestic policy response to soften the blow from the long-awaited consumption tax hike on 1 October.

Keeping the wobbly bike on the road

In our last forecast we described the world economy as a "wobbly bike": fragile and easily knocked over by a bump in the road. Our latest forecast reflects this, with the additional challenge of more protracted trade tensions behind the downgrade to growth.

We are not ignoring the effects of potential changes in monetary and fiscal policy (government tax and spending). Both will provide some offset to weaker activity with interest rates falling and governments looking to cut taxes and raise spending.

However, we expect there to be a longer-than-normal lag between policy easing (i.e. cutting interest rates) and stronger economic activity. This reflects caution about taking on debt following the last global recession but primarily it is because monetary policy can do little to reduce the drag from global economic and political uncertainty.

 

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