Perspectives
    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.
    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.

On the Same Theme

The decline of commodity prices: A matter of concern? 12/7/2018
Oil and metals prices are down significantly this year. For oil this seems to be predominantly driven by supply factors. The decline of metal prices probably reflects the softening of global growth. There is a clear negative relationship between oil price changes and subsequent US real GDP growth. US growth is expected to face a number of headwinds in 2019 but the decline of the price of oil should act as a tailwind.
The strange debate about central bank independence 11/23/2018
Is central bank independence under threat? The question may seem strange. After all, central bank independence has been instrumental in bringing down inflation and inflation expectations in the 80s and 90s.
COP24 should preserve the Paris climate deal 11/21/2018
The COP24 (Conference of the Parties) will take place from 3 to 14 December in the Polish city of Katowice. Aim of the meeting is to make progress on the implantation of the Paris climate deal. CO2 emissions have to be cut by about 20% by 2030 from 2010 levels and reach net zero around 2075 in order to limit global warming below 2°C over pre-industrial times. Yet, they are still trending higher. Certainly, they have somewhat declined since 2000 in the OECD, as production has become less CO2 intensive. By contrast, emissions are growing rapidly in the developing world because of industrialisation and the catching up process. In the BRIICS - Brazil, Russia, India, Indonesia, China and South Africa, CO2 emissions per capita have almost doubled since 2000.  Limiting or, a fortiori, reversing this trend requires much efforts and cooperation. The advanced economies should help the developing countries in climate adaptation and mitigation policies. They have already agreed to jointly mobilise USD 100 billion per year by 2020.
An effective upper bound to QE? 11/16/2018
The balance sheet of the Bank of Japan is now equivalent to the country’s GDP, yet inflation remains stubbornly low compared to the official target. Years of quantitative easing have caused distortions in equity markets and weighed on liquidity in the market for JGBs. There is concern that the marginal effect of BoJ purchases will wane, leading to an effective upper bound to QE. If this were to be the case, the relevance would go well beyond Japan and cause doubts about the effectiveness of more QE in case of a new downturn. 
Uncertainty on the rise 11/9/2018
Fluctuations in uncertainty can have a considerable impact on economic growth via their influence on confidence of households and corporates about the future as well as on the cost of financing. Uncertainty is not directly observable so proxies are used.
How market volatility weighs on growth 11/8/2018
Based on historical experience, the recent increase in equity volatility may end up weighing on future growth.
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.

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