Here in the economics team, we find that it’s a useful discipline to kick the tires on our economic models each month.
As highlighted in ‘Global recovery – mirage or reality’, despite quarterly fluctuations, global growth has been remarkably steady over the last five years, aided by plenty of monetary policy support. Our Economics Roadmap forecasts suggest this regime could continue for a few more quarters. While this view is currently close to consensus among economists, our strategists still have to work out what this means for financial markets.
Economic uncertainty appears to have returned to normal following the Brexit shock and EM bank lending conditions have been aided by strong portfolio inflows into the region. This removes some of the downside risks, but growth is still likely to remain modest. With productivity appearing to downshift, this is sufficient to drive unemployment rates down further. We find global inventories are looking increasingly lean, but with sluggish global capex and global retail sales growth only around average, the global manufacturing improvement is likely to be unspectacular. Headline inflation is set to rise as energy base-effects unwind. The key test is whether this squeezes real incomes, keeping growth subdued but liquidity flowing, or if an increase in nominal wages signals a move to late cycle.
Looking at the country detail:
- US - growth is tracking about 3% this quarter, but this represents catch-up from the weakness in the first half of this year. Underlying growth is probably still around 2% with some rotation away from previously strong consumer spending towards capex as the energy cuts end. Housing and government should also be supportive for growth. We see the Fed hiking in December, and gradually through 2017, but with core inflation still dormant any shocks will likely be met with further delay.
- UK - the UK economy appears to be suffering less than feared, but growth is still likely to slow into 2017 on weak capex, limited housing activity and some cooling in consumer spending as inflation edges back towards target. The Autumn Statement could provide some fiscal support, but for now we assume this will be only modest.
- Euro area - the region has shown little reaction to the Brexit shock. Some gradual moderation in growth is likely as the earlier currency and lower energy price tailwinds fade. The Italian constitutional referendum is the main near-term event risk and we expect the ECB to find a way to address the bond scarcity problem (see Running out of things to buy).
- Japan - we are somewhat below consensus because our models indicate that net trade is set to drag significantly given recent yen strength, but fiscal policy should keep growth positive. On our projections, the Bank of Japan (BoJ) will miss its inflation target by some distance, but following the BoJ’s comprehensive assessment it is not obvious what more monetary policy can do in isolation.
- China - we expect the stimulus from earlier in the year to wear off and for growth to slow into 2017. Policymakers still appear to have the tools to avoid a crisis for now, but the continued rapid increase in debt means the medium-term risks are growing.
- Other BRICs - we are a little above consensus on Brazil despite the recession continuing to drag through mid-year while Russia is now in a recovery phase and India is the best performing major economy.
In terms of risks, we worry most about adverse political developments. Increasing protectionism is an important medium-term risk which could undermine potential growth even further. While it has not happened thus far, there are upside risks from low interest rates encouraging more borrowing and spending. On inflation we see the risks as balanced. Low inflation expectations could be self-fulfilling and commodity prices still remain relatively low. But we also feel that there is less labour market slack than some central banks anticipate.
Inevitably, when we review these forecasts in the future we will have been surprised to some extent. It will be crucial to react quickly when the macro environment changes, and also to take advantage of fluctuations in markets when the underlying picture has not changed to the extent that market movements imply.