Perspectives
    Perspectives - 24 January 2019
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    The slowdown is spreading widely. Although it is reasonable to expect growth to normalise, several sources of uncertainty (fears of a trade war, Brexit, the US government shutdown, etc.) are acting as headwinds. China has already announced new measures, and in the United States, the Federal Reserve is insisting on its patience (concerning inflation) and flexibility when it comes to adapting monetary policy.
    The assumption that the US economy is heading for a landing is gaining ground, not just because of the shutdown. The disruption created by the trade war with China, the appreciation of risk on bond and equity markets, the peaking of the energy sector and the deterioration of real estate indices all suggest less buoyant growth. This view is shared by the US Federal Reserve, which has adopted a more cautious tone and suspended the increase in policy rates pending future macroeconomic data.
    After an eventful first twenty years, the eurozone is moving into a new phase of uncertainty. Growth has slowed markedly, and economic indicators have deteriorated. With temporary shocks and structural drags on growth, 2019 brings numerous risks. Against this background, and faced with underlying inflation that remains too low, the European Central Bank (ECB) is taking a cautious approach to this new year.
    Economic growth has slowed markedly since the second quarter of 2018 and business surveys indicate that it is unlikely to change in the coming months. The exporting manufacturing sector is much affected by the slowdown in world trade. In the coming quarters, the domestic economy is likely to become the major engine behind growth thanks to an expansionary fiscal policy. More fiscal stimulus could be expected if the economy would slow further. This would also shore up the chances of the coalition parties at the next federal election set for 2021.
    2019 is getting off to a less strong start, with economic activity having taken a hit from the ‘gilets jaunes’ protest movement. The collapse in consumer confidence has been abrupt and the global environment looks less certain. Against this background, fiscal policy is being loosened: the new plan to support the purchasing power of lower income households, announced in response to December’s demonstrations, should help consumer spending to catch up, at least in part. It comes alongside measures already introduced in the 2018 budget to support consumers and companies. French growth is therefore likely to show signs of resistance.
    At the end of 2018, Italy and the European Commission agreed on a new 2019 Budget Law, avoiding an Excessive Deficit Procedure. The 2019 public deficit has been lowered to 2% of GDP from 2.4% previously planned, and real GDP growth has been revised downward to 1% from +1.5%. This is still a challenging scenario as overall conditions in the Italian economy worsened in H2 2018. In Q3, GDP fell by 0.1% as investment, both private and public, significantly declined. After the downturn in September, exports in Italy recorded a +9.6% y/y increase in October, while they stagnated in November bringing the value of the sales abroad to 427 billion euros in the first eleven months of the year.
    The current slowdown is in keeping with the European economic cycle. Prospects are still looking relatively good, and Spain’s expected growth rate is among the highest of the big eurozone countries. Unemployment is falling rapidly but it is still massive, especially long-term unemployment. Prime Minister Pedro Sanchez just presented his 2019 budget proposal to Parliament, but he is not sure it will pass. In any case, the deficit most likely slipped significantly below 3% of GDP in 2018, and Spain is preparing to exit the excessive deficit procedure that was launched 10 years ago.
    Economic growth slowed to 6.6% in 2018 from 6.9% in 2017 and should continue to decelerate in the short term. The extent of the slowdown will depend on the still highly uncertain evolution of trade tensions between China and the United States as well as on Beijing’s counter-cyclical policy measures. However, the central bank’s manoeuvring room is severely constrained by the economy’s excessive debt burden and the threat of capital outflows. Moreover, whereas Beijing has pursued efforts to improve financial regulation and the health of state-owned companies over the past two years, its new priorities increase the risk of interruption in this clean-up process. Faced with this situation, the central government will have to make greater use of fiscal stimulus measures.
    India’s economic growth slowed between July and September 2018, hard hit by the increase in the oil bill. The sharp decline in oil prices since October will ease pressures, at least temporarily, on public finances and the balance of payments, and in turn on the Indian rupee (INR), which depreciated by 9% against the dollar in 2018. In a less favourable economic environment, Narendra Modi’s BJP party lost its hold on three states during recent legislative elections.
    The election of Jair Bolsonaro at the presidency of Brazil has marked a swing to the right, the weakening of traditional political parties and a return of the military to national politics. The new administration faces the challenges of rapidly engaging its fiscal reform, gaining the trust of foreign investors while reconciling ideological differences across its ranks. How society will adjust to a new era of liberal economic policy remains the greatest unknown. Meanwhile, the economy is still recovering at a slow pace. Supply-side indicators continue to show evidence of idle capacity while labour market conditions have yet to markedly improve. Sentiment indicators have shown large upswings in recent months which should help build some momentum in economic activity over Q1 2019.
    In 2018, Russia swung back into growth and a fiscal surplus, increased its current account surplus and created a defeasance structure to clean up the banking sector. The “new” Putin government affirmed its determination to boost the potential growth rate by raising the retirement age and launching a vast public spending programme for the next six years. Yet the economy faces increasing short-term risks. Monetary tightening and the 1 January VAT increase could hamper growth. There is also the risk of tighter US sanctions, which could place more downward pressure on the rouble.    
    The COP24 only succeed in agreeing on rules on measuring, reporting and verifying carbon emissions. In the meantime, the world is falling behind the objective to limit global warming to 1.5°C. CO2 emissions are set to rise to 2030, whereas they should peak by 2020. Countries are underestimating the urgency for action or held back by commercial interests. Moreover, environmental legislation is met by growing public resistance. It demands a better framing of climate policies. Moreover, the climate change discussion should be broadened to the WTO.
    On 15 January 2019, UK MPs rejected the proposed Brexit agreement reached by EU Heads of State two months earlier. With 432 of the 634 votes going against the deal, this result has significantly weakened Prime Minister Theresa May in future discussions with the EU and with Members of Parliament. Today almost anything looks possible, starting with a delay in the official date of the UK’s departure, currently scheduled for 29 March.
    Perspectives - 18 October 2018
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    Growth has eased during the course of this year with the US being the major exception largely thanks to fiscal stimulus. The ensuing cyclical desynchronization has caused a broad-based appreciation of the US dollar, in particular versus emerging currencies. In some cases (Argentina, Turkey), the depreciation has been considerable due to country-specific developments. Global growth should continue to ease further next year and lead to a certain resynchronization: the impact of the US fiscal boost will wane, Fed tightening should start to have an effect and corporate investment is expected to slow, which in turn should weigh on world trade growth. Even in the absence of additional tariff increases, fears of more tit-for-tat measures could sap business confidence.
    With the approach of US mid-term elections, the Trump administration is doing a lot to deliver economic stimulus, through historic corporate tax cuts, increased military spending and financial support to farmers, which are the first collateral victims of the trade war with China. These actions are weighing on the Federal budget deficit, which reports one of its biggest increases ever outside of a recession. The trajectory of public finances seems hardly sustainable, while the rapid expansion of the economy could be also at risk. The full employment of capacities, the peaking of corporate debt ratios and high equity market valuations are all early warning signals of a slowdown, that could materialize as soon as 2019.
    Growth has been moderating in 2018, although remaining above potential. Prices pressure are increasing as signalled by high levels of capacity utilisation, declining unemployment and rising wages. As underlying inflation is projected to move towards the ECB’s 2% ceiling, the central bank decided to reduce net asset purchases and possibly halt them from January 2019. Policy rates will remain unchanged at least through the summer of 2019. The policy mix should stay expansionary and GDP growth may moderate towards its trend rate in 2019.
    Growth decelerated sharply in 2018, although remaining about potential. Tensions in the labour market have resulted in generous pay deals. Nevertheless, underlying inflation has remained subdued. Despite the mildly expansionary fiscal stance and very easy monetary conditions, the pace of economic growth may decelerate further in 2019 due to a worsening external environment. Labour market shortages may intensify in particular in the construction sector. The increase in unit labour costs will gradually spill over into higher consumer prices. Political tensions may intensify, but the prospect of defeat may be the glue that holds the coalition together.
    After a market soft patch in the first half of 2018, growth in France will probably get some colour back in the second part of the year, despite a less supportive external economic environment. Consumer spending should get a boost from tax cuts and increases in social minima planned for the end of the year. This positive impact is expected to last into 2019, buffering the growth slowdown. Other fiscal stimulus measures will also be at work, and the first results of the labour market reforms and the ‘PACTE’ growth and business reform act could start to show up.
    Economic activity has further decelerated. In Q2 2018 GDP slowed to 1.2% y/y. Also, the full recovery of the housing market is further delayed, as real estate prices decreased by 0.2% y/y in Q2. According to the draft budget, the deficit-to-GDP ratio is expected to stay at 2.4% in 2019 and then decline below 2% in 2021. In the government scenario, GDP would increase by around 1.5% in the coming three years, allowing the debt-to-GDP ratio to diminish to 126.7% in 2021.
    Although the Greek economy continues to recover, so far its performance has fallen somewhat short of expectations. After exiting the European financial assistance programmes, Greece’s executive arm has regained some freedom to act, although it is still under “enhanced supervision”. Finding the right trade-offs will be no easy task, between turning around domestic demand, maintaining competitiveness gains and consolidating public finances over the long term, especially with just one year to go before the next legislative elections.
    The Chinese authorities have responded to the economic slowdown and US trade barriers by loosening monetary policy and letting the yuan depreciate in recent months, while considering fiscal stimulus measures. With policies to boost demand, the economic growth slowdown is likely to continue at a moderate pace in the short term. Any rebound in investment, however, is likely to be limited, restricted by the deterioration of export prospects, corporates’ excessive debt, industrial restructuring measures and Beijing’s determination to promote healthier development in the real estate market. As to private consumption, it may not be strong enough to pick up the slack.
    Pressures have been on the rise since April 2018. Narendra Modi’s power has eroded. His party lost its majority position in the lower house of parliament. Growing difficulties in the financial sector have sparked higher refinancing costs. Despite solid growth in the first quarter of fiscal 2018/2019, the rupee has fallen to the lowest level on record after depreciating by more than 13% against the USD. India is vulnerable to higher oil prices (23% of imports) and capital outflows. Although its external position has weakened, India is nonetheless in a much more comfortable position than it was five years ago. At the end of September, foreign exchange reserves still covered 1.4 times its short-term external financing needs (less than 1 year), compared with 0.9 times in 2013.
    The economic, political and moral crisis that has held Brazil in its thrall for several years has crystallised in general elections that have seen a section of the electorate swing to the right. The Roussef and Temer presidencies – marred by corruption scandals and two years of deep recession in 2015 and 2016 – have provided a fertile ground for a further fragmentation of Brazil’s political landscape. The swinging of the political pendulum risks increasing social tensions at a time when the macroeconomic environment deteriorates as growth loses steam, investment contracts, government debt builds up and the external environment looks increasingly uncertain.
    Despite the improvement in economic fundamentals (strong rise in the current account surplus, accelerating GDP growth and a fiscal surplus), the rouble depreciated by 13% against the dollar between April and September 2018. Tighter US sanctions in April and again in August 2018, combined with the threat of new sanctions this fall, triggered massive capital outflows. Despite a highly volatile rouble, bond and money market pressures have been mild. To counter the downside pressure on the currency, the Russian central bank raised its key rates in September, for the first time since 2014, and halted its foreign currency purchases on behalf of the finance ministry.
    Activity is unlikely to pick up again after sluggish growth in the first half of the year. Jobs are, however, still being created at a solid pace, cushioning possible spill-over effects from the weakening external environment. Corporate investment remains rather slow, partly because of geopolitical tensions. The budget stance remains too accommodative, as further fiscal consolidation seems rather unlikely, given the upcoming federal elections in May 2019. Growth is projected to slow to potential and inflation could decline to 1.5% by end 2019.
    On 29 March 2019, the European Union and the United Kingdom will officially separate. Yet the terms of the separation have yet to be worked out. The Withdrawal Agreement, which is indispensable for a smooth exit, calls for a transition period of a little less than two years, through the end of 2020. It will to be discussed at the 18 October European Council meeting. Agreement on the divorce terms has always run up against the Northern Ireland question. Assuming the European heads of state and governments can solve this issue and a deal is finally reached, it would then be up to the UK Parliament to give its consent. This surely poses the greatest threat to a smooth Brexit.

On the Same Theme

Federal Reserve: monetary policy self-assessment 3/8/2019
  The Federal Reserve will conduct a review of its monetary policy framework and the conclusions will be made public in the first half of 2020. Three questions will be addressed: should the monetary policy stance take into account past misses of the inflation objective? Are the tools adequate? How can communication be improved? The initiative should be welcomed because it shows the Fed’s efforts for being ready when the next recession hits. Facing similar challenges, the ECB is likely to be interested in the outcome of the Fed research.
Uncertainty: a moderate decline 3/8/2019
When households (companies) feel more uncertain, they will spend (invest) less. After a jump last year, the number of media articles mentioning uncertainty, has declined somewhat recently (top left chart).
Sentiment measures offer mixed picture 3/1/2019
The latest survey data show a very mixed picture. In the manufacturing sector, China saw some signs of stabilisation, whereas Japan experienced a deterioration. In Germany, manufacturing remains under pressure. The picture in the eurozone is quite diverse, depending on the country and the sector. Looking at the broadest survey indicator for the eurozone, one observes a stabilisation. Whether this will be confirmed depends to a large degree on developments in China and on the well-known sources of uncertainty (trade, Brexit).
Where climate change and inclusive growth meet 2/27/2019
Climate change and inclusive growth are closely linked. Low income households will tend to suffer more from the negative economic consequences of global warming. Policy measures to reduce carbon emissions may also have a relatively speaking bigger impact on low income households. These topics are discussed by William De Vijlder in the final podcast of this series. Interview conducted with François Doux.  
Sustainable globalisation 2/19/2019
Globalisation has traditionally been considered as an irreversible development underpinned by four key drivers: choices by households and companies; technology, which meant that distance became less and less a hurdle in optimising the business of a company; financial markets, with the opening up of capital accounts; pro-free trade government policies. It has become under pressure in recent years (not everybody has benefitted; impact on the environment; problem of speculative capital flows) so it is necessary to make globalisation sustainable. Go further : discover the podcast series dedicated to sustainable globalisation.
Foreign versus domestic drivers of weaker sentiment 2/15/2019
 Since early 2018, based on the purchasing manager indices, a large number of countries have witnessed a decline in the assessment of new export orders which was bigger than the decline of the general climate in manufacturing. This suggests a dominance of foreign demand shocks, rather than domestic shocks, in explaining slower overall growth. The drop in new export orders echoes the significant slowdown in world trade growth. This is probably related to slower Chinese growth and, in many countries, slower growth in capital expenditures, which have a higher import content than consumption. Trade-related uncertainty may also play a role. 
Getting to a low carbon economy 2/7/2019
The Paris climate deal, concluded at the COP21 in 2015, pleads for keeping global warming below 1.5°C above pre-industrial levels. However, in its latest report, the IPCC (Intergovernmental Panel on Climate Change) warns that current mitigation policies are insufficient to obtain this objective. Investments in renewable energy and electricity infrastructure have to be stepped up. The power sector has to be decarbonised, the use of electricity increased, and energy efficiency improved. Low carbon policies are difficult to implement because of commercial interests and social impact, in particular concerning the increase in carbon prices. Nevertheless, to achieve substantial reductions in greenhouse gas emissions, a different approach is needed, including carbon pricing and trade sanctions.
What explains the downward revisions to growth? 2/7/2019
The recent weakening of economic data has led to a downward revision in growth forecasts of the IMF and in the ECB Survey of Professional Forecasters. We have lowered our eurozone forecasts for 2019 as well.
Why recessions trigger fear 1/29/2019
A significant growth slowdown triggers anxiety that worse is to come. Households and companies hate uncertainty, confidence drops and a negative spiral develops. Although central banks may adopt a more dovish tone, the minds will still be dominated by a feeling that growth is missing.
Slowdowns, households, companies and banks 1/29/2019
Slower growth will raise the concern of households that unemployment will increase. Greater caution means less spending. Companies will scale back investments because they represent a long horizon commitment which moreover is irreversible. Reduced visibility means companies will be reluctant to commit for the long run. Banks will also become more cautious in extending credit, being concerned that the balance sheet quality of customer will suffer from a period of negative growth.

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