When it comes to growth, better may prove to be the enemy of the good
The US fiscal stimulus will boost US growth to the point of driving it to dangerous, but still distant, heights. Bringing it down gently from there will be a difficult task for US monetary policy. The natural slowing of the European cycle and the consolidation of growth in the emerging sphere can thus continue, subject to twin conditions: the absence of any excessive tightening by the Federal Reserve and of an all-out trade war. These two risks do not seem imminent, however, and a “reasonable” optimism still seems to be in order.
The US fiscal plan comes at a particularly bad time, temporarily boosting economic growth already at the top of its cycle.
Although the fiscal stimulus is not likely to boost potential growth, it is prompting us to revise US growth upwards, to just under the 3% mark, in 2018 and 2019. This is higher than the US potential growth rate, estimated at 1.8%, and could drive the unemployment rate down towards 3.5% by end-2019, well below the Fed’s estimate of a full employment rate of 4.5%. While inflation is not threatening to pick up very sharply, the Fed’s monetary tightening will speed up. The US Central Bank will have the difficult task of guiding the economy towards a soft landing in 2020 and beyond by gradually eliminating its monetary easing measures. The new Fed chairman, Jerome Powell, will seek to implement a balanced policy designed to ward off any overheating and achieve its inflation targets. The Fed will need to show extreme virtuosity and an acute sense of proportion to avoid premature rate rises that could stifle growth on the one hand, and on the other, rises that come too late, and which could lead to a cycle of overheating and recession.
In the Eurozone, the recovery phase, accompanied by its share of nice surprises, is now behind us and the economy is settling into its growth phase.
The sometimes disappointing findings of the surveys are not flagging up a cyclical reversal, but its natural slowdown. They reflect nothing more than expectations adapting to reality. The confidence of economic agents has become more consistent on the strength of developments in the real economy. The strength of the fundamentals suggests further sustained growth rates, of close to 2.4% in 2018 and 2.1% in 2019, with no significant pick-up in inflation. There is thus no threat of a monetary emergency and the ECB’s monetary policy should very gradually become less accommodative.
The emerging world should see stable growth of around 4.7% in 2018 – satisfactory without setting pulses racing.
The main source of improvement in the growth outlook is still exports, which until now have grown at a fairly sustained rate. Stronger global growth and exports could (at last) prompt some emerging firms to b more willing to consider investing, creating the conditions for a slight pick-up in some emerging countries, (but not in China).
What are the main threats likely to derail the natural slowing of the European cycle and disrupt growth consolidation in the emerging world? The risks are all American, namely the dosage of US monetary tightening and its impact on the markets, and President Donald Trump’s hawkish trade policy.
Steering US monetary policy will be a tough task, but a sharp tightening does not seem on the cards, because there is no pressing need to contain over-strong inflation. After precisely worrying about a return of inflation, US rates seem to be entering a consolidation phase: the pick-up on nominal growth seems “digestible”. Eurozone rates, for their part are edging towards a very gradual increase, despite the ECB’s tapering of Quantitative Easing and expectations of a (very modest) rise in inflation .
And what about President Trump’s variable geometry protectionism? At this stage, it would be premature to embark on an hazardous calculation of the economic impact of the tariff increases he has announced, which involve temporary exemptions, in particular. It is easy to understand the intentions and the virtually exclusive target by looking at a few numbers, which, although sketchy, say a great deal about US foreign trade. The trade deficit in goods and services reached 566 billion dollars in 2017, or close to 3% of GDP and the highest deficit since 2008. While trade in services saw a surplus of 244 billion dollars, trade in goods ran a deficit of 810 billion dollars. The largest contributor to the US trade deficit is, obviously, China, with a US deficit of 375 billion dollars – way ahead of Mexico (71 billion), Japan (69 billion) and Germany (64 billion). Moreover, the deficit is concentrated on a small number of significant products such as cars, which generate a quarter of the trade deficit. Note in passing that the US is the second biggest export market for the German automotive sector. It is easy to imagine the difficulty of coming up with a joint, offensive strategy on the part of the European Union. We should, therefore, expect that any retaliation measures are likely to be used sparingly to avoid triggering a trade war and darken growth prospects, especially in the Eurozone. China, for its part, has responded with tough talk but so far limited action. Other reprisals than those announced so far (and amounting to only 3 billion dollars’ worth of US exports) are possible, of course. Some 19% of Chinese exports go to the US and correspond to 3.6% of its GDP. China’s trade surplus with the US accounts for 63.5% of its total surplus. China is likely, therefore, not to react excessively as it would have a lot to lose right now if a trade war with the US were to break out.
The risk of an imminent, all-out trade seems limited. On the other hand, escalating protectionism is currently the greatest pitfall facing the global economy.
For more information, consult our scenario : World - Macroeconomic Scenario for 2018-2019: When it comes to growth, better may prove to be the enemy of good – 4 April 2018