US outlook benign, but questions remain over Europe and Japan says Schroders’ Keith Wade
Keith Wade, chief economist at Schroders, says the US is on track for recovery that would enable the Federal Reserve to start winding down QE, but Europe continues to drag on the global economy.
Our global growth forecasts are little changed this quarter with global activity expected to rise 2.4% this year before picking up to 3.1% in 2014. The forecast recovery is well below par when compared to past upswings which regularly recorded growth rates of 4% (see chart front page). Slower growth can largely be attributed to the weakness of the Eurozone which is still expected to spend 2013 in recession with a contraction of 0.7% (previously -0.6%). The Emerging market economies are also contributing less than in previous cycles and we are trimming our 2013 forecast for the region to 5% (previously 5.2%).
Meanwhile, the US recovery remains on track (we still expect 2.1% growth this year) and we have revised up our forecasts for Japan (to 1.6% from 1%) and the UK (to 1.1% from 0.6%). Both upgrades owe much to a better than expected start to the year, although business surveys suggest recovery will continue in Japan, validating Abe-nomics.
The transatlantic divide
Going into 2014 we see continued global recovery led by the US which has made the most progress of the major economies in adjusting to the aftermath of the financial crisis. By virtue of its “mark to market” financial system and the decision to recapitalise the banks at an early stage, the US has largely wiped the slate clean and is in a strong position to resume growth. By comparison, Europe still has some way to go with the IMF estimating that peripheral banks still need to de-lever by $1.5trillion1. Arguably this is too pessimistic, but the differences in the two regions are highlighted by the divergence in credit creation and bank lending surveys.
Factors shaping growth:
(i) The changing impact of fiscal policy
We still see scope for activity to pick up in Europe next year as austerity eases. The European Commission has begun to take a more relaxed view of countries who miss their fiscal targets, pushing out the period over which they have to adjust their deficit to 3% of GDP. There seems to be an increasing recognition in Brussels that tightening policy to make up cyclical shortfalls in budget deficits is counterproductive in the current environment. Fiscal tightening for the Eurozone of 1.1% GDP this year drops to just 0.1% GDP in 2014, effectively neutral. Fiscal austerity is also expected to be less significant in the US next year with the headwind dropping from 1.7% GDP this year to 0.8% GDP in 2014. In contrast, Japan will be heading in the opposite direction: after a small easing of policy this year, an increase in the consumption tax results in a tightening of around 2.5% GDP in 2014 using IMF projections. There is a debate as to whether Japan should skip such a tax increase on fears that it will push the economy back into recession.
Memories of 1998 when a rise in the consumption tax did just that are still painful. However, with public debt to GDP running at 238% GDP at the end of 2012, there seems to be little option but to start reining in the budget deficit. As a result there is no further acceleration in Japanese growth next year in our forecast which predicts growth will remain close to 1.5%. Ironically the consumption tax may push inflation in Japan to 2% thus allowing the BoJ to claim success in hitting its inflation target. However, this is likely to be short lived (as the tax increase will drop out in the following year) and with fiscal policy likely to be on a tightening tack in subsequent years the Bank of Japan (BoJ) will remain under pressure to keep policy loose. Consequently we assume that the Japanese yen (JPY) continues to weaken (to 115 against the USD by end-2014).
Overall, fiscal policy will still be tightening in the advanced economies, but the headwind in the US and Eurozone will have eased off. We can probably say the same for the UK; as, although the IMF figures suggest “Plan A” will continue and fiscal policy will tighten at a steady 1% GDP per annum, with a general election due in 2015 the political cycle suggests an easier stance.