A personal view from Ian Stewart, Deloitte’s Chief Economist in the UK. To subscribe and/or view previous editions just google ‘Deloitte Monday Briefing’
The weather may have been good but the global economy has had a lacklustre summer. Activity has been disappointing and forecasts for GDP growth next year are drifting down.
The pace of the slowdown has forced central banks to reverse course and start easing policy. In August, having spent more than three years raising interest rates, the Federal Reserve cut US rates for the first time in more than ten years. The Fed is likely to cut rates again later this month; the European Central Bank (ECB) seems set to do so when it meets this week. China has stepped up bank lending in the last 18 months to try to bolster growth.
Trade tensions are at the heart of the slowdown. The trade dispute between the US and China has broadened from exports of solar panels, washing machines and metals to a vast array of goods. Retaliatory actions by China and other countries affected by US tariffs have driven tariff levels higher. The latest round of US tariffs, announced on 1 September, involve a 15% tax on products including TVs, printers, smart watches and speakers and Bluetooth headphones. (AirPods and the Apple Watch will be affected.)
The US-China dispute has increasingly assumed a strategic character. The US has tried to deny Huawei access to US components and wants to prevent it from helping build 5G infrastructure in the West. China responded by drawing up a blacklist of ‘unreliable’ foreign firms. China has warned its citizens over the risks of travelling to the US claiming official harassment of its nationals. Last month the dispute ratcheted up as China allowed its currency to weaken, falling below the symbolically important seven yuan to the dollar level. The US interpreted it as a competitive devaluation designed to gain export advantage and promptly dubbed China a currency manipulator.
Higher import prices will squeeze consumer spending power in importing nations. The threat to supply chains has created new uncertainties for business and forced some to reassess their sourcing strategies. President Trump appears to want US companies to pull out of China, tweeting, “our great American companies are hereby ordered to immediately start looking for an alternative to China”.
The mood music on trade is changeable. Hopes that the US and China would strike a deal buoyed equity markets earlier this year, only to be dashed. The US and China are due to re-start negotiations in October but given the wide-ranging nature of the disagreement a comprehensive solution seems unlikely.
In the glory days of globalisation, economic and financial networks widened and strengthened, helping power global growth. Now, with what one US academic described in the Financial Times last week as a “weaponising” of global trade networks, those channels are acting as a conduit for slower growth.
The effects can be seen in the decline in global export growth and weakness across Western manufacturing. Germany runs the world’s largest trade surplus and is the world’s third biggest exporter and is especially exposed. German business confidence has slumped and manufacturing output has contracted since the start of the year. The economy shrank in the second quarter; there is a fair chance it will do so again in the third quarter, which would put Germany in a technical recession.
Financial markets assume that central banks will come to the rescue by easing policy. With the Federal funds rate at 2.25% the US has scope to lower rates. Doing so in the euro area where interest rates are already negative, and depositors pay to hold money with the ECB, is more problematic. Driving rates still lower would increase deposit costs, already running at €7.5 billion a year for banks, increasing the incentives for the private sector to hoard cash rather than deposit it in banks. In this way pushing rates further into negative territory could discourage bank lending. It is for this reason that the ECB may restart quantitative easing – or the buying of assets to support their price, increase liquidity and reduce market rates – having called a halt to it last December.
Growth may also get a helping hand from governments. The mood among politicians and policymakers on public sector austerity seems to be turning. Donald Trump’s administration has presided over a huge programme of debt-funded tax cuts. Last week the new UK government announced significant increases in public spending and a review of the borrowing rules which many believes presages the end of a ten-year programme of debt reduction. Christine Lagarde, the outgoing head of the IMF, has urged euro area countries to use fiscal policy to boost spending.
Germany is the obvious target of such advice. Its public finances are in surplus, government borrowing is effectively subsidised by negative interest rates and parts of its infrastructure are creaking. (A focus on balancing the budget means that bridges, roads and public buildings built in the 1960s and 1970s have not received the necessary upgrades since the turn of the century.)
This all needs to be seen in perspective. Most major economies are continuing to grow. Labour markets are generally strong, pay pressures are building and across much of the world consumers are consuming. The general view among forecasters is that growth will continue over the next year, albeit at subdued rates.
In financial markets the view that monetary policy is losing its power to drive growth seems to be gaining ground. Investors are holding government bonds with negative yields partly because they doubt central banks will be able to keep propping up growth. The challenge for the ECB this week, and the Fed later this month, is to make them change their minds.
PS: I have not commented on the slew of political news from the UK but I have revisited the opinion polls and the political betting odds. As of Friday, betting markets implied a one in five chance of the UK leaving the EU by 31 October and around a 90% probability of a general election taking place this year. The same markets implied a 70% chance of the Conservatives winning the most seats but only a one in three chance of their winning a majority. Punters think the most likely outcome is a hung parliament, with an implied probability of around 60%. A YouGov opinion poll undertaken at the tail end of last week, on 5–6 September, put the Conservatives on 35%, Labour on 21%, the Lib Dems on 19% and the Brexit Party on 12%.
If realised at a general election the Electoral Calculus model estimates these shares would deliver a substantial Conservative majority. Such estimates are subject to significant caveats: the timing of an election, the focus of the campaign, the performance of the Brexit Party, regional variations and turnout are unknown and all would impact the result.
Betting odds and opinion polls have a mixed track record in predicting political outcome. Seven weeks before the 2017 general election betting markets implied a 93% chance of Theresa May winning a majority. Most opinion polls immediately prior to the Brexit referendum suggested remain would win. The result of the 2015 election did not turn out as the pollsters expected. Whether voters will follow their traditional party allegiances or back the party that best represents their view on Europe is, perhaps, the greatest unknown.