Global Economic Outlook January 2015 Philippe WAECHTER Head of Economic Research My twitter account @phil_waechter or http://twitter.com/phil_waechter My blog http://philippewaechter.en.nam.natixis.com
Synthesis The US economy will remain the main driver of the global economy This reflects its capacity to have a internal demand driven growth model Europe and mainly the Euro zone will be the good surprise for 2015. The lower euro, the drop in the oil price and a very accommodative monetary policy will feed demand and be a support for recovery. The United Kingdom is doing well but its growth rate will not accelerate in 2015 In 2015 and 2016 industrialized countries will be the leaders of the global economy, emerging countries and China will be followers. That's a real difference with what was seen during the first decade of the 2000's Chinese growth is trending downward as its economic model changed and because there are a lot of imbalances from the past that reduce its capacity to adapt rapidly. Japan is still in recession and it will have a low profile in 2015 The inflation rate profile is on the downside. Energy prices will pull down inflation rates close to 0% in 2015. But core inflation rates are still below central banks' target. The expected recovery in the Euro zone will reduce the risk of deflation Monetary policies will remain accommodative in 2015. A possible liftoff of interest rates can be expected during the second part of 2015 by the Fed. But the absence of surge in inflation is an incentive to maintain low interest rates In the Euro zone, the ECB will maintain very low interest rates and will provide ample liquidities (TLTRO and QE) in order to maintain the euro currency at the very low level in order to increase the probability of a sustained recovery 2
The Global Economy The economic activity momentum is still low. The world industrial production growth trend has been divided by 2 when it is compared to the pace seen before the crisis. This is due to the low dynamics in developed countries, mainly in the Euro Area and in Japan. The US economy is now following a stronger trend. For emerging countries, indices are still growing but at a slower pace than they used to do. The influence of China lower momentum is clearly perceived. World trade figures are consistent with this reduced momentum. Its yearly change is still way below the trend seen before the crisis. This environment is consistent with lower commodity prices. The oil price has been divided by a factor two when it is compared to the first half of 2014 average. Low demand is the key issue to understand the oil price profile. Nevertheless, there is reduction in demand and no producer really wants to take the initiative to reduce its production. We can imagine that the oil price will remain low for a long time period. 3
United States of America The US economy is now following a strong trend. This real recovery has started last spring. This can be seen on employment figures. When monthly jobs creation for 2014 are compared to the average of the three previous years, there is a drift since April. Jobs creation numbers are now higher than they used to be. This change has been noticed in GDP growth figures. During the third quarter, the US economy has grown by 5% at annual rate. The main driver for this recovery is the private internal demand. Households consumption and investments are the main support for GDP growth. Nevertheless, the current business cycle is weaker than previous cycles. This shows the strength and the persistency of the financial crisis. This difference can clearly be seen in the second chart. The graph would have been the same with jobs creation figures. This late recovery explains the absence of push on wages and the absence of inflation risks. This growth framework will continue in 2015 but inflation will still be below the Fed's target. That's why the Fed still have time before the liftoff of interest rates 4
China The main issue on China is that the economic activity will not come back on the 10% GDP growth seen on average since 1980. One reason is the will for the middle class to take advantage of the comfort given by higher wages. It means that the economy is now more oriented on the service sector than it used to be. It makes a difference in productivity. This change in the growth model has been seen since 2012. It requires a re-allocation of resources from the industrial sector to the services sector. It's usually a long transition. If this is longer than expected, it is also due to constraints that reflect imbalances from the past. Excess in the real estate market, overcapacity in some industrial sectors and debt overhang in some public companies can highlight the long transition and at the end the weaker growth dynamics seen in China This has a strong impact on the inflation rate. As internal demand is weaker than expected, consumption and production price indices are trending downward. There is a need for a more supportive fiscal policy (but that could be able to avoid the mistakes done in 2009) and a very accommodative monetary policy in order to reduce real interest rates. 5
Japan Japan is back to recession and there is no reason for a rapid change. The Japanese economy was doing well in 2013 with a QQE from the Bank of Japan and a supportive fiscal policy through public investment. The value of the yen dropped rapidly, inflation was higher, but not too much, and growth was almost strong. But before all these elements took place, the government has decided to increase the VAT rate. It was done on April the 1 st in 2014. Since then internal demand follows a low trend and pulls down the growth momentum. The higher inflation rate after the VAT had a strong negative impact on consumers' purchasing power and then on their expenditures. The VAT hike was probably too early in the cycle. Now the government tries to implement strategy that will support consumption. It's probably a little too late and there is a risk of negative growth for 2015 6
United Kingdom The economy is changing in the United Kingdom. This can be seen in the first chart. During the first part of the recovery, new jobs were mainly part-time jobs. This is no longer the case. This shows a stronger economy and stronger expectations. During the second part of 2014, the negative impact from other European countries has constrained the economic activity. Nevertheless, consumption was strong and supportive for growth. The interesting point is that wage dynamics is now stronger. We can see that on the second chart. The real wage, even when we use core inflation to calculate it, is now growing. This is a real change even if the real wage is still well below its 2010 level as it can be seen on the chart. It will be supportive for consumer expenditures and internal demand As the inflation rate is now at 0.5%, in December, there is no more incentives for the Bank of England to increase its interest rates. Due to the low expected inflation rate for 2015, the probability of a rate change starting in 2016 increases rapidly 7
The Euro Area The second part of the year has been weak for the Euro area. GDP growth rate was just 0.3% and 0.6% at annual rate in the second and third quarters respectively. The first chart shows that since 2011 the dynamics is weak reflecting the consequences of austerity policies. These fiscal and monetary policies have constrained the private internal demand by increasing taxes or by reducing government expenditures. The main consequence of theses strategies is the reduction of the demand addressed to companies. The weak recovery seen since the first quarter of 2013 reflects the fact that the private internal demand is not able to support a strong growth trajectory. The absence of an endogenous recovery is the source of the ECB strategy. The lower euro is just a way to create a shock that can change behaviors. The lower the euro the stronger the impact on the economy and on employment. 8
Inflation The inflation rate is low almost everywhere. Except Japan, most industrialized countries have an inflation rate below 1% while central banks' target is 2%. Of course this comes from the low energy price, but this explanation is not sufficient. In the current recovery, goods and services prices are not strong enough to compensate the drop in energy price. In Draghi's mind, a weak economic momentum would be the main source for a deflation episode in the Euro Area. As growth and internal demand are weak, there are no pressures on prices and also ne pressures on the labor market. If there is a recovery in the Euro Area in 2015, expectations will change and the probability of deflation will decrease. In the USA, the late recovery implies low pressures on the economy and on the labor market. We do not expect a inflation rate spike this year, this reduces the risk of an early liftoff of the Fed's rates 9
US Monetary Policy The US economy now follows a strong trajectory. This could reflect tensions inside the USA economy but this is not the case yet. In fact the recovery has really started last spring and it's too earlier to have tensions. This can be seen on the labor market where wages grow slowly, less than 2% on a year in December. I don't expect a rapid surge in inflation. The main reason is that the participation rate of people between [25-55] of age is decreasing. These people will not retire rapidly. So if the labor market continues to improve they will be back and will not allow a strong increase of wages. That's the reason why the Fed has time before a liftoff of its own interest rates. On another point of view, due to the oil price deep drop, the inflation rate will be well below the Fed's target. The next step for the US central bank will be a raise of its interest rates but it will not be before the second half of this year (may be in 2016) and this increase will not be brutal. The last chart shows that expected growth (the difference between the two curves) in five years is limited. This is a puzzle for the Fed 10
ECB Monetary Policy The ECB analysis of the Euro Area is that growth is too slow and that internal demand is not spontaneously able to create a stronger growth environment. The ECB idea is to change the conditions of the Euro Area. One way to do it is to improve pricecompetitiveness by driving down the value of the European currency. This will create an impulse on exports and on economic activity. The first step for that is to drop short term interest to zero. That's what has been done at the September meeting. Draghi has convinced investors that very low interest rates are here to stay, at least until the end of 2016. After this announcement the euro parity has slid to 1.15 against the dollar The second step is to provide ample liquidity. The ECB wants first to provide liquidity against the transfer of risks from banks to the ECB (TLTRO, purchases of covered bonds and of ABS) in order to create conditions for the banks to amplify the initial impulse on activity through new loans. The second part associated with a QE is to drive down the euro exchange rate and to maintain at a low level for long. In that case, the Euro economy will be able to take advantage of this new environment. 11
Euro Exchange Rate On the first chart, we see that the divergence between monetary expectations, the blue line, and the euro dollar exchange rate has been dramatically reduced since the end of 2014. This reflects the fact that investors are convinced that the ECB monetary policy will remain accommodative for a longer time period than the Fed's policy. The ECB target now is to maintain a low euro exchange rate One effect of the ECB QE will be to drive down interest rates notably in peripheral countries. The ECB will is to reduce the financial fragmentation. The point here is to facilitate the spillover of the positive shock due to a lower euro to the rest of the economy through banks' loans and investment. 12
Forecasts Year end Monetary Policy Long Term Interest Rates (10 year) 2012 2013 2014 2015 2012 2013 2014 2015 USA 0-0.25 0-0.25 0-0.25 0.5 1.7 3 2.2 1.8-2.4 Japan 0.1 0.1 0.1 0.1 0.8 0.7 0.3 0.2-0.4 Euro Area 0.75 0.25 0.05 0.05 1.2 1.95 0.5 0.6-0.9 U.Kingdom 0.5 0.5 0.5 0.5 1.8 3.1 1.8 1.3-1.8 Source Economic Research Natixis Asset Management 13
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