Downward revisions as advanced economies slow

Downward revisions as advanced economies slow

Shane Canavan Weekly bulletin January 2019
Global economic activity appears to be weakening at a faster rate than expected after a relatively robust 2018. This week the IMF downgraded its growth forecasts for the second time in three months, warning that ‘the risks to more significant downward corrections are rising’.

The biggest culprit appears to be Germany, the Eurozone’s largest economy, which saw its 2018 growth rate fall to a five year low of 1.5%. Business confidence data fell to a three year low and it is increasingly evident that the country’s problems are deeper than just the short-term impact that new emission standards are having on the auto industry. Expectations are that the forthcoming GDP growth figure for Q4 will be positive but small – meaning that, following a contraction in Q3, Germany will have avoided a technical recession by the skin of its teeth. Meanwhile, the government is expected to slash growth forecasts this week.

ECB Policy

Weakening survey data must be a source of frustration for the ECB. With monetary policy all but exhausted, the Eurozone can ill afford a collapse in investment. In keeping interest rates unchanged, Mario Draghi last week acknowledged that risks had tilted to the downside, citing geopolitical factors including Brexit, the ongoing threat of protectionism, a slowing Chinese economy and the fading impact of US stimulus. The ECB is now expecting interest rates to stay unchanged until at least early 2020, which is consistent with market views. This is a significant downgrade to the optimism of 2018, when the ECB decided to end quantitative easing.

Draghi was not incorrect to blame external geopolitical factors, but he is possibly guilty of an oversimplification. The world’s second largest economic bloc cannot be content to be so dependent on foreign spending – particularly when interest rates are negative. Yet European policymakers at Davos this week seemed very eager to highlight other members’ shortfalls, which included everything from budget infringements and unbalanced tax practices to stealing wealth from former colonies. Now that the euro is out of its teens and into its twenties, a bit more maturity is called for.

Weak data from the Eurozone

This week’s data releases will only add to the pressure, with Eurozone sentiment indicators (Wed) expected to have fallen even further. Thursday’s GDP numbers will likely see growth stay at a measly 0.2% for Q4. Although last week’s disappointing PMI number of 50.7, the lowest for 66 months, could suggest a weaker than expected number. Italy will likely experience a second consecutive contraction in GDP, thereby pushing the economy into recession, and France will also see disappointing GDP figures for Q4. On Friday, CPI is expected to soften to 1.4% as a direct result of lower energy prices. With core inflation expected to remain stubbornly at 1.00%, the ECB is unlikely to face pressure to change its monetary policy stance.

UK uncertainty

Brexit continues to dominate the UK agenda with the IMF observing that the ongoing uncertainty has offset the fiscal stimulus measures announced in the autumn budget. With the 29th March looming and little sign of a compromise agreement the pressure continues to grow. Last week saw businesses voicing their frustration, and in some circumstances utter dismay, at the lack of clarity from the UK Parliament. It is not lost on businesses that the current default position is a no-deal Brexit – something that many firms see as highly disruptive at best.

Greater clarity rather than a resolution could come on Tuesday when MPs are set for another round of votes. Most important will be the swathes of amendments that are likely to give Parliament a greater say in steering Brexit. The expectation is that amendments like the Cooper bill will give Parliament the ability to delay Article 50, thereby reducing the probability of a no-deal scenario. Should these be passed, expect sterling to continue to creep upwards.

Away from the corridors of power the UK labour market continues to go from strength to strength, with unemployment reaching 4.00% – a 44 year low. Wage growth also climbed to 3.4%, the strongest in a decade. With inflation at a two year low, real wage growth reached a two year high of 1.2%. All this continues to support the notion that the MPC will look to normalise interest rates – if and when the Brexit uncertainty is removed.

US interest rates

On Wednesday the Fed is expected to hold rates unchanged, with two rate increases pencilled in for 2019. However, the markets will be looking for any insight into when the Fed is thinking of ending the reduction of bonds on its balance sheet. Having started tapering in October 2017 it is rumoured that the Fed is becoming increasingly conscious of the markets’ aversion to the program. Therefore, as well as pausing interest rate rises in March, the Fed could consider halting quantitative tightening. However, with the labour markets running red-hot, as Friday’s non-farm numbers are likely to reiterate, market rumblings may only distract the Fed for so long.

For more information, please contact Shane Canavan, Director at JCRA, at shane.canavan@jcrauk.com.

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