Perspectives - 10 July 2019
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    A sigh of relief followed the publication of first quarter GDP data. However since, growth concerns have picked up again on the back of a collection of new economic data but also — and perhaps more importantly — due to continued high uncertainty. The latter stems from concerns over the extent of the slowdown and its consequences in terms of economic risks. It also emanates from escalating tensions between the US and China over trade. The effects of this confrontation already show up in the Chinese data while in the US, mounting anecdotal evidence also point to its detrimental impact on business and the agricultural sector. The Federal Reserve has turned a corner and indicated that rate cuts are coming, much to the joy of the equity market. The ECB has also changed its message: with risks tilted to the downside and inflation going nowhere, it considers more easing is necessary.
    Although household consumption remained rather buoyant at springtime, foreign trade as well as investment may have weakened. In June, the business survey results were lacklustre, while the Federal Reserve opened the door to cutting interest rates. Already back on the campaign trail, President Trump is unlikely to soften his hard line on tariffs, although he will surely remain as unpredictable as ever. The economy is likely going to need some support.
    With the export sector hard hit by US tariff measures and private consumption growth weakening, investment growth has slowed. Although domestic demand could pick up in the short term, bolstered by monetary easing and fiscal stimulus measures, export prospects depend on the outcome of trade talks between Beijing and Washington, which remains highly uncertain. The authorities are bound to use foreign exchange policy sparingly to avoid creating a source of financial instability. Moreover, the current account surplus has improved again in recent months.
    Although Japan’s economic openness is relatively limited, the high concentration of Japanese exports to China, and the other Asian countries in general, creates a major external risk for the dynamics of Japanese growth. This situation is squeezing the manufacturing sector, but for the moment, its difficulties do not seem to have carried over to the other sectors of the economy. The VAT increase planned for October should encourage households to make some early purchases, while the high level of uncertainty is hampering corporate investment. In this environment, the Bank of Japan is expected to maintain a very accommodating monetary policy, although this is unlikely to trigger a sustainable upturn in price inflation.
    The months pass but nothing seems to change. Growth in the manufacturing sector is struggling to accelerate in a persistently uncertain international environment, while buoyant domestic demand is boosting activity in services. The stronger-than-expected first quarter performance sends a more optimistic message than economic surveys. Faced with a downturn in inflation expectations and the downside risks to the Eurozone’s economic scenario, the European Central Bank (ECB) has been proactive again. It is prepared to ease monetary policy further and the new measures have been set up much earlier than expected. Yet faced with stubbornly mild inflation and only limited manoeuvring room, the ECB is bound to take a frugal approach.  
    As international trade slows, the economy is mainly supported by expansionary fiscal and monetary policies and real disposable income growth. After a mild contracted in Q2, the economy is expected to grow modestly in the second half of the year. In 2020, exports may strengthen again and growth could return to close to potential. Due to its deep integration in global value chains, Germany is relatively hard hit by the global trade slowdown. This integration has undoubtedly brought benefits by improving productivity and skill-intensity. However, it has also accentuated income inequality.
    The signs of stabilisation seen at the beginning of the year have been followed by improvements in confidence surveys. The upturn in consumer confidence has been the most marked and the most encouraging of these. The rather more mixed nature of the economic data available tempers these positive signals somewhat, and leads us to forecast stable growth in Q2, at 0.3% q/q, making this the sixth quarter in a row to see growth at around this pace. This stability, which is remarkable in and of itself, is likely to continue over the coming quarters according to our forecasts. It is a good sign of the resistance of French growth to downward pressures. Under our scenario, this resistance demonstrates a degree of effectiveness in the measures taken to support consumers and businesses.
    In Q1 2019, Italy came out of recession. The overall scenario remained mixed. The GDP annual growth rate was negative. Imports strongly declined and exports slightly increased, with a positive contribution of net exports. Both households and firms remained cautious, postponing consumption and investment. Cyclical indicators suggest a disappointing evolution in coming months, making more challenging the fulfilment of public finance objectives. The Italian Government approved an update of the 2019 Budget, with the public deficit around 2% of GDP, reaching an agreement with the European Commission and avoiding the disciplinary procedure.  
    Spanish growth is still robust, but that does not mean it is totally immune to the European slowdown. Although growth is expected to slow this year, it should have no trouble holding above an average annual rate of 2%. After winning April’s legislative elections, Pedro Sanchez is still seeking a majority that would enable him to head the executive branch and form a new government. Spain officially exited the European excessive deficit procedure recently. Although a budget has not been formally adopted for 2019, the authorities are aiming for a primary surplus.
    GDP growth is slowing due to the strong deceleration in global trade. Nevertheless, the economy continued to operate close to its potential until 1Q 2019 thanks to the strength of domestic demand, underpinned by strong disposable income growth and an expansionary fiscal policy. As the government has lost its majority in the Senate, it needs the cooperation of the opposition parties for passing new legislation. However, a government crisis is not imminent. Even if GDP growth is expected to slow below its potential in the coming quarters, public finance metrics will continue to improve up to 2020.
    Over the next quarters economic growth will remain stable. Rising labour market capacity constraints and a lower contribution by net international trade are weighing on the overall outlook. With also uncertainties in the international (trade war, Brexit) and national (government formation talks) context unlikely to dissolve anytime soon, our base case is one of below potential growth up until 2020.
    Denmark’s small open economy is bound to be hit by the economic slowdown affecting its main trading partners in the quarters ahead. Household consumption will remain the main growth engine thanks to job creations, wage growth and mild inflation. With consumer prices up only 0.7% y/y in May, inflation should remain mild. The Danish economy is also expected to benefit from an accommodating monetary policy in the quarters ahead, although this will depend on the policy stance adopted by the European Central Bank (ECB).
    Brexit has been behind thirty-seven resignations from the government responsible for managing the process, the latest being that of Prime Minister Theresa May herself. Having failed three times to get the Withdrawal Agreement through Parliament, she had little choice but to ask for an extension of the Article 50 period and then in the end to resign. The two candidates to take her place are the current Foreign Secretary, Jeremy Hunt, and his predecessor, Boris Johnson. Whilst Mr Johnson claims he can negotiate a changed deal and trigger Brexit from 31 October 2019 (the latest deadline), Mr Hunt plans to seek more time in order to renegotiate to allow for an orderly exit.
    The economic recovery continues. Growth is accelerating and for the moment it has reached the lower range of expectations. After four and a half years in power, Alexis Tsipras passes on the helm to Kyriakos Mitzotakis, leader of the centre-right New Democracy party, which has led in the polls since 2016. The new Prime Minister is unlikely to call into question the prescribed public finance trajectory as the country exits the European financing programme.  
    The robust GDP growth reported in 2018 is bound to slow this year. Sweden’s main trading partners have been hit by slowdowns, which is having a negative impact on export momentum. The slowdown in job creations will also strain household consumption. Yet it is the reduction in residential investment that is expected to curtail economic activity sharply in the months ahead. Although inflation should near the central bank’s 2% target by the end of the year, monetary policy will probably remain accommodating in the months ahead due to the uncertainty surrounding economic trends.
    Perspectives - 19 April 2019
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    Recent data in China and the eurozone point towards a stabilisation of growth and have been met with relief. Although the US economy is slowing, growth should remain at a satisfactory level in the near term. Yet there are lingering concerns about the underlying strength of the global economy. The IMF has again scaled down its forecasts and only expects a modest growth pickup later this year. The flattening of the US yield curve fuels worries that growth will disappoint. The Fed insists it is confident about the outlook and patient in setting its policy. Markets have welcomed this accommodative message. Yet the signals sent by equity and bond markets about future growth are quite different. It only adds to the list of concerns.
    Although losing steam, the economic activity in the US is seen keeping on a rather dynamic path in 2019. The International Monetary Fund still forecasts a 2.3% increase in GDP this year, while delivering an increasingly cautious message in the meantime. The IMF recently pointed out several risk factors, including the record high corporate debt ratio, the opacity and less stringent standards on the leveraged loan market, and stretched equity market valuations. Moreover, the inversion of the yield curve is virtually complete, which in the past has always been an early-warning sign of recession.
    The eurozone’s manufacturing sector has been hard hit by the decline in foreign trade and persistently high uncertainty. Very open internationally, the eurozone is sensitive to global cyclical slowdowns. Internal macroeconomic fundamentals are still solid, and the rally in the services sector is showing resilience. The ECB has taken note of the longer than expected slowdown, and has opted once again for longer-term refinancing operations (TLTRO). Numerous risks still cloud the forecast horizon, which could darken rather quickly if any of these risks were to materialise.
    Since the middle of 2018, economic activity has virtually stagnated largely because of a slowdown in world trade. The most recent surveys and hard data confirm that weakness in the manufacturing sector continued in Q1 2019. Spearhead of the economy, the sector can become a source of vulnerability when world markets are less buoyant. However, Germany is able to support domestic demand. In 2019, the government will return to households and businesses a part of last year’s record budget surplus (more than EUR 50 bn).
    Business confidence surveys are showing signs of levelling off. Hard data for January and February are rather positive. These factors are consistent with the economy keeping up growing at about 1.2%, which is our growth forecast for 2019. Although this is not very high, it is synonymous with the resilience the French economy is expected to show in an environment marked by uncertainties and downside risks. The main factor behind this resilience is the positive impetus of economic and fiscal policy, notably stimulus measures to boost household purchasing power, and the expected ensuing rebound in household consumption.
    The Italian economy entered the third recession in the last ten years. In 2018, value added in the manufacturing sector recorded four consecutive contractions. Domestic demand disappointed, as both households and firms remained extremely cautious. Given the deterioration of the overall scenario, in the 2019 Economic and Financial Document recently approved, the Italian Government has lowered from 1% to 0.2% the GDP growth expected in 2019, with public deficit at 2.4% and the debt to GDP ratio at 132.6%. The structural deficit would worsen by 0.1%, to 1.5%. A progressive ageing of the population makes the scenario even more complicated.
    In a morose economic environment, Spanish growth stands out as one of the most resilient in the eurozone, and it seems to have entered the year at a very similar pace to the one in H2 2018. The main factors behind this resilience can be found on the household front, where the savings rate has dropped back to the low point of 2008. With only a few days to go before the 28 April general elections, the electoral landscape is still highly fragmented. Regardless of the outcome, the winning party will find it hard to form a sustainable majority coalition.  
    Industrial enterprises were squeezed by tighter financing conditions in 2017 and early 2018, and then hit by a slowdown in production and revenue growth last year. These troubles have contributed to the deterioration of their payment capacity, resulting in a surge in defaults in the local bond market. The increase in defaults is an indicator of the financial fragility of corporates, and also seems to be going hand-in-hand with greater differentiation of credit risks by lenders and a certain clean-up of the financial sector. These trends are expected to continue in the short term as the authorities conduct a targeted easing of monetary policy. However, the persistence of the debt excess in the corporate sector will maintain high credit risks in the medium term.
    After nearly five years in power, Narendra Modi’s track record is generally positive, even though the last year of his mandate was tough, with a slowdown in growth in Q3-2018/19. The main growth engines are household consumption, and more recently, private investment, thanks to a healthier corporate financial situation, with the exception of certain sectors. In full-year 2018, external accounts deteriorated slightly as a swelling current account deficit was not offset by foreign direct investment. A big challenge for the next government will be to create a more conducive environment for domestic and non-resident investment.
    The hopes of seeing economic activity pick up following the election of Jair Bolsonaro have fallen. Some indicators point to a possible contraction in economic activity in Q1 2019 at a time where confidence indicators were seemingly improving. Meanwhile, the reform of the pension system – a cornerstone of President Bolsonaro's economic program – was presented to Congress in February where it is currently under discussion. Negotiations will likely be more protracted and be more difficult than originally expected. Indeed, since taking office, the popularity of the Brazilian president has sharply declined and relations between the executive and the legislature have strained.
    Economic growth slowed in the first months of 2019, and is now close to its potential growth rate of 1.5% according to the central bank. A 2-point VAT increase on 1 January has strained real wage growth and sapped household consumption. Inflation (5.2% year-on-year in February) is still below the central bank’s expectations, and the key policy rate was maintained at 7.75% following the March meeting of the monetary policy committee. In the first two months of 2019, investors were attracted by high yields on Russian government bonds, despite the risk of further tightening of US sanctions. The rouble also gained 5% against the US dollar in Q1 2019.
    Economic activity in Japan remains in a slump, and the slowdown observed in 2018 seems set to last. Manufacturing activity deteriorated in the first quarter. In the short and medium term, Japan will continue to be hard hit by the slowdown in China, its main trading partner. Demographics are still a major problem in a country where the over-65 age group continues to swell and now accounts for more than a quarter of Japan’s total population. It serves as a constant incentive to boost productivity gains through large-scale structural reforms in the goods and services markets as well as in the labour market.
    By opting to leave the European Union (EU) without any exit plan, the United Kingdom has come face to face with an impossible choice. Week after week, the Brexit impasse has revealed the British Parliament’s incapacity to make decision, starting with the ratification of the divorce terms, the fruit of 2-years of negotiations by Prime Minister Theresa May. In the end, the Brexit was simply postponed. First set for 29 March, then 12 April, the deadline for exiting the EU has now been extended to 31 October (a Halloween treat?). This date could be moved forward if the UK finally manages to ratify the withdrawal agreement, which it has rejected time and again. But the most probable scenario is that the UK will extend its participation to the EU, at least for a while…

On the Same Theme

Elevated uncertainty slows growth despite lower rates 9/6/2019
Business surveys in the US paint a diverging picture: manufacturing is worsening significantly but services have picked up nicely. Taking a broader perspective, evidence is building of a slowing economy. Less dynamic growth can be observed in engines of growth of the world economy: China and India, although reasons differ. In Europe, Germany is probably already in a technical recession whereas France is resilient. Central banks are back in easing mode but the effectiveness will be hampered by elevated uncertainty, despite the announcement of a new round of trade negotiations between the US and China.
Monetary easing at full employment: how effective? 7/12/2019
Fed Chairman Powell, in his address to Congress this week, has confirmed that easing is coming. In June, ECB President Draghi provided similar hints. This comes on the back of growing concerns regarding global growth and ultimately facing too low a level of inflation. Risks may be mounting, but, on the other hand, the unemployment rate is close to the natural rate. There are reasons to assume that monetary easing under full employment would be less effective than when the economy is marred in recession. Monetary easing could also raise concerns about financial stability, which, if unaddressed, could weigh on the ability of monetary policy to successfully boost inflation.
Exogenous versus endogenous uncertainty and monetary policy 7/5/2019
 A high level of uncertainty can act as a drag on growth. Whether monetary easing will succeed in boosting growth will depend on the nature of uncertainty. Endogenous uncertainty follows from the normal development of the business cycle and rate cuts should succeed in reducing this uncertainty by boosting confidence of economic agents. Exogenous uncertainty is not driven by the business cycle but is triggered by other factors, such as, in the current environment, ongoing trade disputes. In this case, monetary policy effectiveness suffers and, despite rate cuts, the growth slowdown should continue until its root cause (exogenous uncertainty) is addressed.  
Uncertainty: persistently high 7/5/2019
High levels of uncertainty can have a profound impact on economic activity and financial markets. Our Pulse presents different metrics.
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Climate change: household balance sheets 6/28/2019
How does climate change impact the household balance sheet? Households’ assets and liabilities may be subject to climatic hazards. In many countries, this lesson was learned the hard way. That is why households should be aware of the environmental impact of the companies they choose to invest in or work for. In this second podcast’s episode, William De Vijlder emphasizes the particular importance of climate change in household finances.
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Climate change: public sector 6/28/2019
This last episode focuses on the impact of climate risk on the public sector balance sheet. How will states address the challenge of climate change? How will they manage the climate debt? Will they be able to implement the appropriate investment policies in a context of pressure on tax revenues? William De Vijlder exposes in this podcast the tremendous challenge faced by the public sector and the answers it is starting to provide.
Central banks: synchronised swimming against the tide 6/21/2019
ECB President Mario Draghi, speaking at Sintra, has raised expectations of renewed policy easing.The message from the FOMC meeting is that rate cuts are coming. This policy synchronisation reflects shared issues (inflation too low versus target) and shared concerns, the major being rising uncertainty. Should this continue, the effectiveness of monetary accomodation will suffer.

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