(Continued from part 1 of the economic outlook for the rest of 2016)
So why is growth so lacklustre and is its sluggish pace likely to change any time soon? We think the culprits are public and private sector debt levels, which remain high in many countries. Abundant manufacturing production capacity is weighing on business investment, despite high corporate profits in the US and Japan and favourable financing conditions. This in turn can also stymie trade growth, which makes for a challenging environment for those emerging economies that have traditionally relied on exports to underpin their growth cycles.
Low commodity prices should be positive for the global economic outlook
We think commodity prices have given a boost to consumers in the eurozone, the US, Japan and some emerging economies. But this time around US consumers have saved more of the windfall than they used to. Simultaneously, the drag on business investment has been more pronounced.
And of course there are the structural problems in both Japan, where the monetary and fiscal stimulus under ‘Abenomics’ has so far failed to sustainably lift growth and inflation; and China, still struggling with the transformation from an investment-led to a consumer-led economy. China’s economy is beset by a combination of overcapacity in some sectors, excessive debt burdens that are still rising too quickly and an emerging real estate bubble.
We think that the jaded global growth picture will likely continue to be a feature of the second half of 2016. In the US the consumer should do relatively well, as balance sheets have been repaired, income growth is solid and housing market developments should be supportive. However, the currently high business inventories will, in our view, be a drag on growth. Business investment looks unlikely to accelerate much at this point.
Low productivity growth in the US has positive and negative sides
Low productivity growth reduces the potential growth rate and thus prospects for prosperity in the longer term. It also creates a challenging environment for corporate profits. On the positive side, it enables employment to grow and unemployment to decline, even with modest GDP growth. So conditions in the US labour market should continue to tighten.
For the eurozone we continue to anticipate domestically-driven growth. The main question here is what impact Brexit will have. In our view Brexit is a regional, not a global shock. The initial market reaction was a flight to safety: equities and commodities sold off, corporate bond risk spreads widened, government bond yields fell and gold jumped higher. Yet the sell-off, especially in equities, was short-lived. Bank shares suffered from the drop in global bond yields, but there was no systemic stress.
Exhibit 1: The vote for Brexit on 23 June 2016 gave rise to a flight to safety in asset markets – in developed bond markets, yields of government bonds fell – one consequence of Brexit has been to accentuate the phenomenon of extremely low interest rates in developed bond markets.
We do however think that the Brexit vote will be negative for the UK economy. We expect numerous business investment decisions will likely be put on hold and that consumer confidence will likely take a hit from the weaker pound and higher inflation. Falling property prices could put consumers under further pressure. These factors will, we think, push the UK economy into recession by the end of the year. For now we expect a short recession in the UK but the severity will clearly depend on the negotiations between the UK and the EU about future trade relations.
As the UK is the eurozone’s largest trading partner, this has implications for the common currency area. We think that the recession in the UK will drag eurozone growth to below its trend rate in the final quarter of this year, but that the economy should recover thereafter.
In Japan, a fiscal stimulus package and a relatively tight labour market should provide something of a counterweight to a stronger yen and its impact on corporate profitability and business investment. However, lacklustre growth and a lack of structural reforms will keep inflation low and exacerbate doubts about the efficacy of ‘Abenomics’, the government’s stimulus and reform programme.
We expect the Chinese economy to slow further as the effects of the government’s massive stimulus in the first half of the year fade.
Brazil and Russia should gradually recover. But the recovery will be slow in Brazil, as households are likely to prioritise debt reduction and the government must address its large fiscal deficit. Russia has to adjust to lower oil prices while consumer spending power is under pressure from a sticky rate of inflation.
Overall, we are cautious on emerging market growth due to the slowdown in China, the absence of a global investment and trade cycle, the lack of reforms in many countries and high indebtedness in some of them. [divider] [/divider]
This article was written on 19 July 2016 in Amsterdam
This article is part of our recent ‘Investment outlook’ and ‘Economic outlook’ series.
Here are the links to all the articles: