The new normal
Overall, global conditions remain expansionary. The US economy is growing and we see some tentative signs of improvement in the eurozone. Although Chinese worries have given rise to substantial volatility in financial markets recently, we think that the pivotal economy will still manage a soft landing, which will prove sufficient to offset trouble elsewhere. Monetary policy will be tightened in places like the US and the UK, but rates will be capped at lower levels than we have been used to in the past. Markets have already adapted to this new normal.
The US is developing in line with expectations, despite the turmoil in emerging economies. New jobs are being created as the economy expands. Against that background, the Fed is on track for a first interest rate hike this year. However, the timing is still uncertain. Although recent labour market data seems to provide firm backing for such a move, the Fed will still want to feel reasonably confident that inflation will move back to its target over the medium term. Regardless of when the Fed decides to hike, interest rates are likely to be capped at low levels in a historical perspective.
The eurozone faces stronger headwinds than we expected before the summer, resulting in a weaker outlook for the second half of the year. Growth in exports and corporate earnings has been on the low side. Apparently, the deteriorating conditions in many emerging economies have partly offset the positive effects of the weaker euro. Monetary policy is supportive and credit growth is starting to improve, but interest rates will have to remain extremely low as there is no room for fiscal stimulus. The case against the euro remains.
The newsflow out of China has lately focused on the turmoil in the giant economy’s financial system. Most significantly, the weakening of the renminbi has had ripple effects throughout the world. Despite the correction in the equity market, we think that the authorities will be able to manage to pull off a soft landing. Growth will decline gradually over the next couple of years.
Other larger emerging economies are in varying degrees of trouble. Commodity producers like Brazil and Russia are currently in recession. The longer-term outlook is also gloomy, particularly in Russia’s case given its protracted standoff with the west. India is the only member of the BRIC quartet that shines at the moment. Closer to home, the convergence plays in Central Europe remain on track, while Turkey, a country with few excuses, is facing major challenges.
The Nordic countries continue to be a rather diverse group. Denmark seems to have hit a soft spot after almost two years with continuous expansion. Low productivity growth, a lack of investment, high household debt and lacklustre growth in many important export markets are holding back growth. Finland is stuck in a vicious cycle, where weak competitiveness and poor corporate profitability are threatening to turn into a chronic problem of very low trend growth. Due to the fall in oil prices, the Norwegian economy has deteriorated at a faster pace than expected. Norges Bank is likely to cut its policy rate next month as a result.
In Sweden, the economy is shifting into a higher gear and is likely to approach a cyclical peak next year. While exports will grow robustly on the back of a recovery in the eurozone, domestic demand is expected to be the main driver. Given that demand is likely to expand at a faster pace than the underlying productive capacity, a positive output gap will gradually emerge. Domestic inflationary pressures are modest for the time being, but will play a more salient role ahead. However, as the Riksbank likely has an inflationary bias, the policy rate is unlikely to change until the end of next year.
Jan Häggström is chief economist at Handelsbanken