Perspectives
    Perspectives - 11 July 2018
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    Growth assumptions for the world economy remain at a high level in 2018 underpinned by a powerful combination of job creation, rising company profits and easy access to financing. Yet sources of concern have multiplied and others have become far more intense, leading to a sentiment of increased uncertainty. This is predominantly related to politics and economic policy, which leaves room for positive surprises, but if nothing changes, it could also result in ever stronger headwinds for consumer spending, business investment and international trade.
    President Trump’s trade war is becoming more real by the day. Citing national security concerns, the United States imposed aluminium and steel tariffs on its main trading partners in June. Retaliations followed, prompting the White House to decide further sanctions, first against China. The risk of escalation has never seemed so high, and clouds are beginning to loom over world trade. After applauding President Trump’s tax cuts, the equity and corporate bond markets are showing increased nervousness. So far, the US economy is maintaining momentum, but recent cyclical indicators are less euphoric.
    The slowdown in eurozone growth seems to fit within the “normal” progression of the economic cycle. After a period of strong growth, it is not surprising that activity returns to a pace more in keeping with fundamentals. In this environment, the normalisation of growth marks the beginning of the normalisation of monetary policy. But this should take quite some time. The ECB has already announced that it does not intend to raise key rates before summer 2019. The convergence of inflation with the central bank’s target will still require a high level of monetary support.
    Economic activity has slowed in the first half of the year. Business cycle indicators, on a declining trend since late 2017, have lately shown signs of stabilisation. They still point to robust growth, supported by rather accommodative monetary and fiscal policies. Economic growth is increasingly hampered by capacity constraints in particular in construction. Moreover, generous wage settlements and the lack of skilled workers will stimulate the offshoring of production capacity. Inflation should gradually increase due to higher production costs.
    In the first part of 2018, several factors undermined French growth, including temporary ones like tax increases and transport strikes, and imponderables, such as the upward pressure on oil prices. In the second half, growth is expected to accelerate again as domestic support factors regain the upper hand (healthier job market, planned tax cuts, and favourable financing conditions and economic policy). Dynamic world demand is another, more uncertain part of our central scenario, which places downside risk on our growth outlook of an average annual rate of 2% this year.
     At the beginning of 2018 the Italian economy decelerated. Real GDP rose 0.3% with negative contributions from both net exports and investment. Household consumption increased, supported by the recovery in the labour market. In Q1 2018, employment in Italy returned to its pre-crisis level thanks to the increase in the number of dependent employees. During recent years, the state of public finances has improved. In 2017, the public debt-to-GDP ratio fell to 131.8%. The new government have presented a detailed programme with the simplification of both fiscal and pension systems and the introduction of universal income support. The new minister of treasury stated that the new measures will be consistent with the goal of reducing the debt-to-GDP ratio. 
    The outlook is good. Although economic growth is no longer accelerating, it remains strong and is pushing down unemployment. The only cloud on the horizon is the slow pace of fiscal consolidation. That is less a deliberate policy than the result of difficulties experienced by minority governments since the end of 2016. Pedro Sanchez’s government was brought to power by a diverse majority, and could have at least as much trouble as its predecessor in implementing its policies. In the circumstances, we would not be so surprised if an early general election takes place before the scheduled date in 2020.
    Beijing is worried about the economic slowdown and its effects on the financial health of Chinese corporates. Domestic demand growth is weakening and the external environment is worsening, notably because of protectionist measures taken by the US. The authorities are adjusting their economic policy accordingly. They have slightly loosened monetary conditions, without changing their objective of cleaning up the financial sector and state-owned enterprises. They have also let the yuan lose 5% against the dollar in the last three months. It is now essential for the yuan’s depreciation to remain under control, in order to avoid any dangerous capital outflows and further pressure on the currency, as seen in 2015-2016.
    India has not been spared from the mistrust of international investors since April, even though growth has accelerated strongly. At a time of rising inflationary pressures, the central bank raised its key rates in June for the first time since 2014. This monetary tightening combined with the troubles reported by state-owned banks could strain the recovery of corporate investment, even though companies are in a better financial situation. Banks, in contrast, have accumulated financial losses of more than USD 9 bn following rule changes for the classification of credit risk. These losses account for nearly 75% of the amount of government injections into the banking sector in fiscal year 2017/2018.
    The recession is over, although there are signs that the recovery is flagging. Brazil has avoided a financial crisis. However, the fiscal situation remains very worrying and there is still a crisis of a political, social and even moral nature, with a general election also coming up in October. Against a background of emerging-market tension since March, international investors are worried that the next Brazilian administration might move away from the reform agenda. On the positive side, Brazil has addressed its macroeconomic imbalances – other than its fiscal ones – while its banks are solid and private-sector agents have deleveraged.
    Economic activity rebounded in Q1 2018 and the outlook for growth is still upbeat. Household consumption is expected to boost activity in the second half of 2018, bolstered by higher real revenues. Yet inflationary pressures could intensify with the rouble’s depreciation and the prospects of a 2-point VAT hike in January 2019. A gradual increase in the official retirement age starting in 2019 should help offset some of the structural constraints hampering growth potential, by increasing the share of the active population and reducing spending allocated to financing the pension fund deficit.
    Growth suffered from harsh winter weather at the start of the year and may have caught up slightly in the second quarter. However, the UK growth could slow down further because of the prospect of trade conflict with the United States, along with Brexit uncertainties. The UK is still struggling to turn the agreement in principle about the terms of its exit from the European Union into practical legal provisions. In the circumstances, it is very hard to predict exactly when the upcoming rate hike will take place, despite high inflation and a very low unemployment rate.
    The economic upturn continues even though growth peaked in 2017 at the highest level in 15 years. Growth is still higher than its long-term potential, and is expected to hold above 2% in 2018. The labour market is very dynamic, although the size of job creations also reflects weak productivity gains. The banking and public finance situations are improving steadily. Under this environment, Portugal gradually regains favour with the main rating agencies. Compared to the first months of 2017, the easing of sovereign rates has been spectacular.
    Perspectives - 16 April 2018
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    High confidence levels, a global economic upswing, cautious central banks, sustained job creation and companies’ stepped up investments: enough reasons to feel comfortable when assessing the outlook for world economic growth. Yet a feeling of unease has been on the rise in recent weeks. The softening of sentiment indicators confronts us with the question of what happens after the peak. Is the flattening of the yield curve in the US a harbinger of bad weather to come? Should the share price decline of certain tech companies be read with the experience of TMT stocks in 2000 in mind? Will US inflation end up overshooting the Fed’s objective? And last but not least, to what level will the trade disputes escalate?
    The United States is tightening its trade policy and moving increasingly away from the rules of the World Trade Organisation. After applauding President Trump’s tax cuts, the equity markets are less charmed by his protectionist threats. The transnational imbrication of trade means that it is unlikely to contract, but the atmosphere has certainly become more conflictual. For the moment, the US economy continues to boom. With GDP growth forecast at 3% in 2018, the economy is entering its ninth year of expansion. It is also beginning to show a few signs of tensions, which are likely to encourage the Federal Reserve to continue tightening its monetary policy gradually.
    The recovery is expected to continue at a robust pace in 2018. In any case, that is what the most recent confidence surveys indicate. From a more fundamental perspective, the absence of inflationary pressure suggests that the economy still has some unused resources. Persistently robust growth raises questions about the true levels of the output gap and potential growth rate. This double uncertainty explains why patience, persistence and prudence remain the ECB’s watchwords despite strong growth.
    Despite the strong recovery, the newly formed grand coalition agreed on an expansive fiscal policy. Infrastructure investment is stepped up and support to families and pensioners increased. On Europe, the coalition remains in favour of the Growth and Stability Pact. However, in the short-term the macroeconomic effects of the programme are likely to be limited, as the economy is already operating at full capacity. In the long-term, the economy should benefit from the investment in infrastructure. Enterprises might hold back on investing in Germany given the tight labour market, generous pay deals and high corporate taxation.
    In 2017, French growth moved up a gear: it reached 2% in annual average terms, after 1.1% in 2016, and accelerated in the fourth quarter to a pace close to 3% a year. 2018 is expected to be another year of strong growth (2.3%, in annual average terms, according to our forecasts) but with a different quarterly pattern and breakdown. Indeed, we see growth plateauing or decelerating slightly from one quarter to the next. The surveys data available for the first months of the 2018 are sending a similar message of a likely peak in growth in Q1. In terms of its engines, we expect average annual growth to be supported by an acceleration in household consumption and exports which would take over from private investment.
    The recovery has become more self-sustained, benefiting from stronger domestic demand and net exports turning positive again. In 2017, real GDP rose by 1.5%. Labour market conditions further improved, supporting household expenditure. Favourable financing conditions and fiscal incentives continued to bolster expenditure on capital goods and advanced digital technologies. In 2017 the number of housing transactions increased for the fourth year in a row, albeit at a slower rate than in the past. Several indicators predict a mild improvement in the real estate sector’s general conditions in the months to come.
    Seven years after Fukushima, Japan has seen a rebound in activity driven mainly by the international environment, but also by the expansionist policy of its Prime Minister, Shinzo Abe. Exports are running at full throttle, unemployment is down to a tiny proportion of the active population, and the stock market is nearing record highs. However, behind this economic upturn, the backdrop has changed little. Heavy, recurring public deficits, massive debt, low SME productivity, poor resource allocation, labour market duality, low female labour participation… the Japanese economy still faces a number of chronic problems at a time when population ageing is accelerating.
    Despite the current economic recovery and a persistently favourable international environment, it is still premature to hope for sustainable fiscal consolidation. The errors of fiscal policy in past years have left their mark in the form of deteriorated public finances. The new administration that will take power in January 2019 will face the formidable task of meeting high social expectations while laying down fiscal targets that reassure investors. Structural reforms will have to be reintroduced, such as the pension reform that was swept under the carpet by the Termer administration. Without structural reforms, Brazil’s public finance trajectory could become unsustainable in the medium to long term.
    Russia consolidated its macroeconomic fundamentals in 2017. The economy swung into growth of 1.5% after contracting 0.2% in 2016. The fiscal deficit narrowed sharply to 1.4% of GDP thanks not only to higher oil and gas revenues but also to spending cutbacks. The central bank has demonstrated its capacity to face up to rising credit risks and troubled banks. The creation of a “bad bank” should help clean up the banking sector even further. Despite persistently strong headwinds that are preventing growth from accelerating, the rating agency Standard & Poor’s has upgraded Russia’s sovereign rating to BBB-. However, new US sanctions against oligarchs should weigh on economic growth.
    On the positive side, growth is accelerating rapidly and should return to levels close to the potential growth rate as of fiscal year 2018/19. Private investment finally seems to be entering a sustainable recovery. As part of a bank recapitalisation plan, public banks, whose asset quality has deteriorated further, received an injection of nearly USD 14 bn in March, which should help ease the pressures on the most fragile banks and bolster the rebound in investment. On the negative side, the government has taken a pause from the consolidation of public finances. The current account deficit has widened slightly, reflecting a deterioration in the terms of trade and a decline in export market shares.
    Trade tensions between China and the US are growing. China continues to enjoy a very strong external financial position, and exports to the US account for only 4% of its GDP. Therefore, any implementation of tariff hikes by the US should have a moderate direct impact on China’s macroeconomic performance. However, protectionist measures could dampen its export growth and constrain the industry’s efforts to climb the value chain, whereas China is starting to see a slight loss of its world market share. Moreover, weaker-than-expected growth in exports and GDP could shake the determination of the authorities to slow the rise in domestic debt.
    Greece is preparing to exit the European bailout programme. Activity is slowly picking up, driven by a positive economic environment and renewed confidence boosted by the programme’s smooth progress and prospects of it coming to an end. The country must now kick start its economic recovery. Greece has a large budget surplus before debt interest payments, and is preparing its return to the capital markets. Public debt is high (180% of GDP), but will only be refinanced very gradually. Negotiations currently in progress with Brussels could further strengthen its sustainability.
    Economic growth is expected to accelerate slightly in 2018 as Norway benefits from the favourable cyclical environment of its main trading partners. Investment is also expected to boost activity thanks to favourable growth prospects and persistently advantageous financing conditions. Job creations and wage growth are expected to boost household consumption while the government will make use of a more favourable environment to pursue a less expansionist fiscal policy.

On the Same Theme

A sudden drop in risk appetite 10/12/2018
The eruption of US equity market volatility, with global spillover effects, is a delayed reaction to a rather significant increase in bond yields since the second part of August. Market-implied inflation expectations didn’t move that much so the rise in long term rates reflects an increase in real yields which in turn is related to strong growth numbers. Historically the relationship between weekly changes in yields and stock market performance is weak. This implies that one should focus on drivers of investor risk appetite and in particular signs of slower growth.
Uncertainty indicators send conflicting signals 10/5/2018
The newsflow based measure of uncertainty about economic policy continues to increase. More worryingly, German companies increasingly disagree in their assessment of the business climate, a development which points towards increased uncertainty. This may end up influencing business decisions. On the other hand, stock market based uncertainty remains very low, both in the US and the eurozone.
Markets feeling better though nothing has changed 9/21/2018
Judging by the recent developments in financial markets, investors feel more upbeat. On the economic front (growth and the outlook for monetary policy) nothing has really changed. The euro has benefitted from the ‘risk-on’ environment despite a widening interest rate differential with the US.
Global economy: Ten years after, where are we? 9/20/2018
Looking at the economic landscape ten years after the global financial crisis of 2008, a mixed picture emerges. In most countries per capita real GDP is higher than before the crisis and the unemployment rate has moved back to a level close to or even below the pre-crisis level. However this has required a huge stimulus effort, in particular on the monetary front. Persistent low inflation has meant that, in the US, rebuilding monetary policy leeway to a sufficient degree has not been warranted whereas in the eurozone this process hasn’t even started. Public sector debt hasn’t declined, despite the growth environment and sharply declining interest rates. The build-up of corporate debt in foreign currency in several emerging markets, fueled by an environment of abundant liquidity in developed economies, has increased their sensitivity to spillovers from US policy tightening or a stronger dollar. In addressing the next recession, when it comes, countercyclical fiscal policy will likely be constrained by high public sector debt rather than by the level of structural budget deficits. It implies that in addition to efforts in strengthening the resilience to economic downturns (structural reform policies) and in avoiding the build-up of imbalances (macroprudential policy), thinking about how to address the next downturn, whenever it comes, should be high on the agenda.
Ten years after: The uncomfortable new normal 9/14/2018
Ten years after the collapse of Lehman Brothers, assessing to what extent major economies have fully recovered from the ensuing global financial crisis and the Great Recession very much depends on the perspective which is chosen. A mixed picture emerges: in most countries per capita real GDP is higher than before the crisis. But public sector debt hasn’t declined and growth has been slow, despite the expansionary policy stance. Policy rates are still (very) low and central bank balance sheets are vastly bigger . Policy leeway hasn’t been restored which implies that thinking about how to address the next downturn should be high on the agenda.
Decline of manufacturing sentiment slows down 9/7/2018
Since the end of 2017, most countries have witnessed a decline of the Markit PMI index for the manufacturing sector. The pace of decline is slowing however in the past 3 months compared to the previous 3 months. This and the still high level of the index in many countries point towards an ongoing satisfactory growth pace.
Debt, ten years on 8/29/2018
The Lehman bankruptcy in September 2008 made an abrupt end to unbridled debt accumulation in the preceding years. In the ensuing Great Recession, households and corporations were forced to cut back spending. To stimulate activity, central banks reacted by slashing interest rates, while government stepped up spending. Moreover, to shore up the financial sector, private debt arising from the property bubble ended up becoming state-owned, in particular in the eurozone’s peripheral countries. Deleveraging has progressed only slowly. The household debt-GDP ratio started to decline from end-2009 onwards, in particular in the eurozone. In the other countries, it has remained very close to its peak. In the non-financial corporate sector, the debt ratio has been virtually unchanged despite considerable improvements in profitability, as low interest rates have made debt financing very attractive. The low interest rate environment has also eased the urgency for fiscal consolidation. The government debt ratio started to decline only from mid-2016 onwards, supported by the ongoing economic recovery.  
Threats on international trade 7/18/2018
While international trade is strongly growing again, there is increasing concern about rising protectionism. Under the impetus of their president Donald Trump, the United States has been questioning the very principles of multilateralism which govern world trade since the post-war period. In May 2017, the US triggered a renegotiation of the North American Free Trade Agreement (NAFTA). Then, the US has imposed tariffs on imported steel and aluminium and launched an inquiry into imports of vehicles and automotive components. Retaliatory measures are taken and the risk of an escalation is significant. If it materialises, all the countries, not least the US, would lose and the global economy would slow down considerably.
Conflicting perspectives raise eyebrows 7/13/2018
Speculative positioning in VIX futures shows investors expect volatility to remain low, which implies an absence of growth or inflation shocks. The flattening of the US yield curve shows investors expect slower growth. These conflicting views may reflect differences in investment horizon but in the end, only one of the two can get it right, which is a source of concern.
Uncertainty: Thus far increase has been limited 7/13/2018
Uncertainty has a considerable influence on decisions by households and companies. Because it is not directly observable, proxies are used: indexes of economic policy uncertainty based on media coverage, of the dispersion of the assessment of the economic outlook made by German companies, and of the dispersion of individual stock returns in the US and the eurozone.

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