US leaves problems behind, putting the spotlight on others
The recovery from the financial crisis has been painfully slow in the US and even worse in the eurozone and UK. However, the US has been relatively more successful in solving the problems and also has a more competitive business model. As a result, the economy has pulled through despite strong headwinds. The Fed has signalled that a return to more normal policies will be appropriate. The situation is not so fortunate in Europe. The problems, which are both of a short- and long-term nature, are far from resolved. Several large emerging economies are also being challenged. The gradual improvement in the US economy has triggered capital outflows and put the spotlight on structural weaknesses that need to be addressed.
Supported by still-expansionary fiscal and monetary policies, we are confident that the US economy will continue to recover. As the data flow has confirmed, we think that the recovery is gradually becoming more and more self sustaining, thus allowing the Fed to start tapering its asset purchases soon and then go on to tighten policy faster than expected. Nevertheless, monetary policy will remain expansionary for several years and we believe bond yields are set to only increase modestly. The evolving policy stance should not present the real economy with major difficulties, in our opinion.
In the eurozone, the recession is over, at least in a narrow technical sense. Growth will primarily be driven by Germany, while its southern neighbours will keep on struggling with weak domestic demand and financial problems. The crisis economies need to create a massive turnaround in employment, but it is hard to see how this can happen quickly. The ECB has no alternative but to keep rates extremely low for a very long time. In due course, this will push the euro down.
We are somewhat more hopeful about Japan. The authorities’ three-pronged approach, a combination of fiscal, monetary and structural measures, has, in our view, the potential to finally turn things around. So far, however, we have mostly seen the first two components, fiscal and monetary stimulus. It remains to be seen if “abenomics” can deliver on the third component, crucially important, as well.
As for the UK, we believe there is also some reason for optimism. Overall sentiment has recently turned more positive as the outlook for export markets seems a little brighter. However, we do not expect a quick rebound, as households and firms are in a rebalancing phase. In a longer-term perspective, it is essential that the country’s export sector takes a step up to compensate for the retrenchment at home. As in the case of Japan, the jury on what can be achieved in this regard is still out.
The slowdown in Chinese growth continues, but it is stabilising. The cause of the slowdown in China is not insufficient demand. Rather, the economy is running into supply constraints, as the potential for further growth under the current model is about to be exhausted. As a consequence, policy attention has shifted from demand stimulation to structural reforms aimed at improving efficiency and productivity. We believe that this strategy has a reasonable chance of success, at least in a shorter-term perspective, and thus expect only a mild slowdown during the next couple of years.
Supply-side problems are also apparent in other large emerging economies. Strong growth among emerging markets has been a feature of the world economy for years. We now see emerging cracks in this paradigm. From Brazil to India, growth is not what it used to be. There are both cyclical and structural factors at work that explain recent lacklustre growth. Capacity constraints are increasingly binding. While growth has fallen, inflation has not, a clear indication of limited economic slack. In order to overcome these problems, structural reforms are keenly needed. By contrast, expansionary policies would only make the situation worse.
While Sweden has been able to stave off recession during the past couple of years, growth has been modest lately. Exports in particular have underperformed relative to Germany, while activity has been held up by domestic demand. We now think that the economy is likely to shift to a higher gear. We should see growth picking up before year-end. There are three main drivers: a recovery in export markets, an expansionary fiscal policy in the run-up to next year´s parliamentary election, and more upbeat households and firms.
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Jan Häggström, Chief Economist, +46 8 701 10 97, +46 70 761 43 66
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