An Indian summer for world growth?
The title of our first editorial in September 2017 was “A roaring end to the summer”. The talk at the time was of a “Goldilocks” economy. Like Goldilocks’ porridge, the economic environment was neither too hot nor too cold but “just right”, both in terms of growth and inflation. That balance ensured the goodwill of central banks, plentiful liquidity and low volatility. Expectations were underpinned by this serenity and investors tried out riskier tactics beneficial to the trend in valuations. The far-off clouds of protectionist threats and the United States’ inappropriate economic policy could still be qualified as verbal posturing. In short, the economy was akin to a radiant June day.
Since then, growth has slowed (except in the USA, where it is boosted by fiscal stimulus) and inflation has risen, obliging central banks and the Federal Reserve in particular to step up the normalisation of their monetary policy, which is reducing liquidity. Will the global “Goldilocks” moment last a little while longer? Even with more modest growth rates – though higher than the long-term trend – ensuring a continued decline in unemployment and controlled inflation? Is the economy due for an Indian summer, with expansion driven by the intelligent coordination of global monetary and fiscal authorities, serving to reassure investors of the continuation of favourable monetary and financial conditions? Or is an early winter in store as geopolitical threats take real-life form and liquidity dries up?
World growth slowed sharply at the start of the year, but second-quarter data indicated that it had stabilised at slightly over 3%. Information on global trade confirms a recovery in exports, with growth exceeding 3% at end-June. Demand from advanced economies has been accelerated by US growth, the strongest in four years. Demand in emerging economies is recovering at a slightly slower pace than in summer 2017.
Signs of a stabilisation in business activity were legion over the summer, notably with the stabilisation of the oil price, which has hovered around $75 since May. The sea freight index has shown an increase in trade flows since July. But uncertainties weighing on the global scenario have grown more substantial. While the outlook for household demand remains bright (providing the oil price stays put), the main doubts at summer’s end concern the expansion potential of investment. More specifically, with margins expected to shrink and monetary and financial conditions toughen – especially in the USA and emerging countries – the outlook for capital accumulation is growing bleaker. This situation has impacted emerging countries, particularly the most fragile among them. Tensions with the USA this summer brought Turkey’s weaknesses back to light. The sharp depreciation of the Turkish lira can be attributed to the fact that the crisis is both economic and political. The contagion of other emerging currencies was limited to countries with the weakest balances of payments or those under specific political threats (including Russia, impacted by further sanctions). While risks of an economic nature were limited in the euro zone, the risks stemming from the shift in Turkey’s geopolitical stance and its consequences on the increase in migration to Europe may prove destabilising, especially ahead of the European Parliament élections.
The trade war initiated by the Trump administration is beginning to impact investment decisions. In 2018, business confidence was hit mainly by the indirect effect of a potential crisis, but next year the direct effect of higher customs tariffs could impact business activity. In addition, the end of the appreciable synchronisation of world growth is undermining the resilience of this last. Growth in advanced economies may appear to be reaccelerating, but this does not automatically imply an acceleration in capital flows to emerging countries, which are increasingly being separated into good and poor performers. The synchronisation of advanced economies will also be impacted by the nature of the US economic cycle, bolstered by a fiscal policy whose effects are bound to diminish while monetary restraint continues.
In advanced economies, confidence has returned to a level consistent with our forecasts last year, prior to the wave of upwards revisions of growth forecasts that marked the second half of 2017, the result of substantial revisions of national accounts. Advanced indicators, notably August PMIs, confirm the stabilisation of world growth at over 3% in the third quarter, too. The Japanese Tankan indicator in the automotive sector and the Federal Reserve survey on investment show a recovery in the acquisition of capital and transport goods after weak investment in the first half.
In the euro zone, growth slowed in the second quarter year on year, but remained at 2.2%. But it also reflected a recovery in investment, dispelling (for now) fears of an interruption in the virtuous cycle of capital accumulation. In contrast, given the negative contribution of external trade, which looks set to be a constant in the coming years, domestic demand continued to strengthen, with consumption fuelled by the continued fall in unemployment and investment driving demand for capital goods. A lower capacity utilisation rate may well be on the cards, but this could reassure those who were concerned by a premature overheat of the euro zone economy. Surveys in August point to growth of slightly over 2% in second-half 2018, confirming the sustainability of growth superior to its potential. An environment even more favourable to investment will be created by a monetary policy providing monetary and financial conditions that remain largely accommodating and a fiscal policy more propitious to public investment. As long as the spectre of increased US customs tariffs on European cars remains a distant threat and the trade war does not go global, the sustainability of the European economic cycle has every chance of continuing. But the next quarter will be vital to determining the vulnerability of the European economy and gauging the scale and duration of that cycle. At which point, we could be faced either with an Indian summer or an early winter.