The Riksbank and the Fed do a U-turn
The global recovery has further to go. While economic recoveries seldom end entirely of their own accord, recessions are typically preceded by rising inflationary pressures that trigger tighter monetary policy. We expect very few signs of this during our forecast period. One exception is the US, where Fed policy will be gradually tightened during 2015 and 2016, bringing about a slowdown in 2017. By contrast, the eurozone faces clear deflationary risks, providing arguments for measures in the opposite direction. In several emerging economies, there is also scope for gradual monetary policy easing. Against that background, the global recovery will be more extended than is typically the case.
In the US, the economy is developing favourably according to plan and will deliver solid growth this year and over the next few years. Indeed, the US looks set to lead rather than lag the global business cycle. As economic activity strengthens, we expect the unemployment rate to continue to fall. That raises the issue of the appropriate stance of monetary policy. As the Fed is phasing out its bond purchases, the focus of attention has shifted to the Fed funds rate. The unemployment rate is steadily approaching levels that the US central bank likely views as critical. Our analysis suggests that a rate hike is already on the cards before the end of the year. We expect the Fed to continue gradually hiking its policy rate through the first half of 2017, at which point the business cycle will be peaking.
The eurozone is in a gradual recovery but, unlike the US, has not been able to resolve the problems that have been haunting the economy since the global financial crisis. With the exception of Germany and its closest neighbours, unemployment is very high and will not decline rapidly. Budget deficits remain large in several economies and will need to be addressed. Banks are in the process of strengthening balance sheets but credit market conditions are far from normal. Against this background, the ECB will have to deliver further monetary easing and the euro needs to depreciate in an effort to offset present deflationary pressures.
In Japan, the potential benefits of Abenomics seem less impressive now compared to the assessment at the time the three-pronged strategy was launched. While business investment was the main driver of economic activity last year, consumption has lately taken over as households act in anticipation of the hike in indirect taxes. Meanwhile, the yen has stopped depreciating. The Bank of Japan will have to do more on the monetary side, while the “third arrow”, structural reforms, has yet to be launched in a serious way. That is clearly not enough to boost growth in the years ahead.
The UK leads the G7 countries in terms of GDP growth. However, while the dark clouds may have dispersed over the past year, there are still challenges to overcome before we can conclude that this favourable performance will prove sustainable. So far, the economic recovery has been driven almost entirely by consumption, while investment has almost stagnated since the beginning of the financial crisis. Nevertheless, the recovery is there and the Bank of England, following in the footsteps of the Fed, will have to act accordingly.
Although we believe the risk of an imminent financial crisis has been exaggerated, China is facing major challenges. The implementation of President Xi’s ambitious reform programme has been slowed down by powerful vested interests. The short-term growth outlook is boosted by measures to stimulate the economy, a little like last year but not like during the financial crisis. Growth rates remain on a slightly downward trend. Nevertheless, we expect China to make a significant contribution to global growth during our forecast period.
In India, the results of the recently concluded marathon election process have yet to be announced. We and most others expect the opposition party BJP to be the winner. The party is led by Narendra Modi, the current Chief Minister in Gujarat, who is perceived as pro-business and who has promised to lower inflation, speed up development, attract foreign investment and improve rural infrastructure to boost farm income. Although these are good intentions, we anticipate that it will take years to revamp the economy and raise growth. In other parts of Asia, investor sentiment towards most markets has staged a comeback. That turnaround is supported by macro data. The external risks remain intact, the number one risk being a growth slowdown in China. Despite that, the most likely outcome this year is stable and solid growth.
In commodity-based Brazil, the authorities have been grappling with low growth and relatively high inflation for some time. As the central bank has hiked interest rates in response in an effort to rein in inflation, domestic demand is slowing down. We have yet to see inflation coming down, however, and believe that the economy will remain subdued throughout much of our forecast period. In another commodity-driven country, Russia, economic prospects were seen as gloomy well before the crisis in Ukraine moved into the limelight. With Russia having failed to diversify its economy during the long commodity boom, low growth was seen as likely for years to come. After recent developments in Ukraine, there is reason for even greater pessimism. However, while the conflict with the West can still escalate further, we doubt that Russia’s energy exports will be much affected. That also seems to be the current market assessment.
In broad terms, we stick to our rather upbeat view on Sweden. Higher growth in investment and exports should soon join household consumption as strong contributors to high GDP growth this year. While the fiscal policy outlook remains highly uncertain, we forecast a gradual monetary policy tightening. The policy rate may develop in a u-shaped pattern, first a cut in the summer after which it is hiked further out. Going forward, the focus needs to shift from monetary to fiscal policy to promote economic progress and growth. In a longer perspective, we think changes in the macro policy framework are likely, with potential boost to public spending.
For further information, please contact:
Jan Häggström, Chief economist, +46 8 701 10 97, +46 70 761 43 66
For more information on Handelsbanken, see: www.handelsbanken.se
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