Central banks on divergent tracks
The global recovery continues. In particular, we have seen positive signals from the US and China. In the eurozone, economic activity has stabilised. Even there, although the problems are far from resolved, we count on modest growth during the next couple of years. Meanwhile, several large emerging economies are facing inflationary pressures due to capacity constraints. Diverging economic trends imply quite different monetary policies in different countries. Central banks are on divergent tracks. That applies especially to the Fed and the ECB.
In the US, economic activity has gradually strengthened after a low point in the final quarter of last year. Despite tax hikes, government expenditure cuts and the lack of bipartisanship in Washington, growth has remained fairly robust. The unemployment rate is likely to fall further, probably faster than most analysts predict. As a result, the labour market will approach the Fed’s threshold, when a move to a more neutral monetary policy stance is warranted. Against that background, we think that the Fed will start to taper its bond purchases in the next few months. Apart from the real economy arguments, the Fed is also keen to wean the financial system off its dependence on constant liquidity injections and to avoid new bubbles. Such action from the Fed can be expected to strengthen the dollar against vulnerable currencies and may also pressure asset prices elsewhere.
The eurozone economy levelled out before last summer, but growth has remained soft since then. So far, the recovery has not lived up to expectations. High unemployment has the potential to exert strong downward pressure on wage and price levels. The unexpectedly abrupt fall in inflation during the autumn has forced the ECB to stem possible deflation risks. With the policy rate close to zero, deflation is a real risk that has to be taken seriously. The eurozone now seems to be finding itself in the kind of situation that Japan was facing for many years. In many parts of the eurozone, wages and prices are too high in comparison with competitors elsewhere. If the necessary adjustment does not take place through the euro exchange rate, it will happen through nominal wage and price cuts. These rather gloomy prospects will, in our view, motivate the ECB to ease its policy further.
As one of the fastest-growing economies among the G7 countries, Japan’s GDP has finally reached the same level as at the peak in Q1 2008. So far, growth has been driven by private consumption, buoyed by fiscal stimulus. Monetary policy will remain accommodative until consumer prices reach the official percent target. The third and crucial component of “Abenomics”, structural reforms, is hopefully about to be launched.
Broad-based recovery within all sectors of the UK economy is now a fact. GDP is being driven by private consumption, but the outlook for investments has improved as financial conditions have eased. Productivity growth has been absent, but we should expect productivity to rebound sharply. Reaching the forward guidance threshold for the labour market will, in our view, not necessarily trigger rate hikes by the Bank of England.
In China, growth now seems stable after having fluctuated a bit earlier this year. Compared to last summer’s surge led by large state-owned industrial companies, we also find it better balanced. The slowdown in construction activity, especially housing, reinforces this impression. In the short term, growth may turn out a notch stronger than previously expected. However, significant challenges remain. Rising inflation, higher real estate prices and rapid credit expansion have triggered action from the Bank of China. In the longer run, the long list of reforms announced in connection with the Communist Party’s recent plenary meeting may also contribute to growth and stability.
In several other large emerging economies, the authorities are facing more immediate problems. Brazil, India and Russia now have to deal with lower growth, capacity constraints, a slump in investment, and underlying inflationary pressures. Especially in Brazil, the central bank has acted aggressively to hike interest rates. Despite tight monetary policy, exchange rates have weakened significantly in Brazil and India, which in turn of course also has implications for inflation. We think that developments in these three economies, as well as in a number of other emerging economies across the globe, reflect cyclical as well as structural factors. In the absence of vigorous structural reforms, growth is unlikely to return to the levels before the global financial crisis.
In the case of Sweden, we are now seeing signs that the economy is beginning to pick up speed. Finally, manufacturing and exports are making a comeback. Apart from the uncertain short-term outlook, however, we still think there are significant challenges ahead, both for industry and the labour market. Next year may entail some labour market improvement, while inflation is set to stay low. The evolving macroprudential framework may gradually have important implications for monetary policy. Developments in housing prices and household indebtedness in Norway and Sweden illustrate the dangers of pursuing an inflation target without having a macroprudential framework in place to prevent a housing bubble. We are not forecasting a collapse of house prices, but Norway is further into the danger zone than Sweden and policymakers are already starting to worry about recent prices declines. Norway could be seen as a warning bell for Sweden, showing that it is really important to cool down the housing market before it is too late. This has been on the authorities’ radar screens for some time now, and we basically stick to the view on the Riksbank that we have expressed before. In that context, we note that Swedish monetary policy also has to be seen in relation to circumstances abroad, which are set to remain characterised by easy monetary conditions.
For further information, please contact:
Jan Häggström, Chief economist, +46-8 701 10 97, +46 70 761 43 66
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http://research.handelsbanken.se/Macro-Research/Macro-Forecast/Global-Macro-Forecast/
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