It is a decade since the 2008 global financial crisis emerged. That continuing crisis in 2009 led to the only annual contraction in the world economy since the Second World War and also brought the banking system to its knees, to then be bailed out by taxpayers. It also ushered in a period of prolonged monetary stimulus.
Interest rates were slashed, money was printed, and for a while, terms such as “unconventional monetary policy” and “quantitative easing” were heard regularly on the news. Now things are changing. The focus is on when central banks will exit and reverse their cheap money policies and how financial markets and the world economy will cope.
Central banks such as the Bank of England have been the shock absorber for the world economy over the last decade. Now a big worry is that they might become shock creators.
Exit strategies will differ
The path of interest rates and quantitative tightening – in which the printing of money is reversed – will vary from country to country. The US has already begun raising interest rates, hiking them gradually over the last two years, and is set to tighten further. The UK has also started to raise rates, but whereas the Americans have increased rates four times and by a total of 1%, the UK has merely reversed the 0.25% rate cut implemented soon after the result of the June 2016 Referendum. Meanwhile, the European Central Bank and Bank of Japan are still providing stimulus, helping the recoveries that are now well underway in the euro area and Japan.
While the policy profile will be determined by what happens in each country, the global backdrop remains positive. The question is, will this sentiment continue?
Strong indicators across the world
Many economic indicators in the first three months of this year have been good. Perhaps most encouraging has been the stabilisation in the Chinese economy and the stronger profile seen across most emerging economies. These now account for a far bigger proportion of the world economy, hence their improvement is welcome news. Also the US economy has been strong, helped by the President’s tax cuts.
Meanwhile, across many economies, businesses appear more confident about investment. There has also been solid jobs growth in the US, UK, Germany and Japan and a significant improvement in France and across parts of the euro area, where unemployment is now falling from high levels. All this is welcome news.
Trade worries loom large
The strength in world trade over the last year is also encouraging.
However, recent worries about a trade war have dampened some of the enthusiasm about the sustainability of world trade. Indeed, when one considers possible shocks to the world economy, a trade war is the main current concern. The latest signs are worrying – with a tit-for-tat response between the US and China escalating the situation.
It is possible to construct many scenarios from here, including a de-escalation of current tensions. If one considers how the geopolitical tensions in north east Asia, centred on North Korea, have eased over the last few months it is possible – but not guaranteed – that a similar easing of trade tensions could occur. But markets will worry until that happens.
Expect greater volatility
The performance of financial markets in the first few months of this year suggests greater future volatility.
Monetary growth has slowed across a number of countries, including the UK, where it is now growing at half the rate of a year ago. Weaker monetary growth can sometimes be a harbinger of a slowdown in the economy.
Another issue is whether higher inflation will reappear. There is still intense global competition. This, plus new technology, is forcing firms to keep prices down to stay competitive. Although inflation is low, it is worth keeping an eye on oil prices as Russia and Saudi Arabia are trying to push these higher, and on commodity prices, as China recovers. These factors feed into food prices, too. But the big test will be over what happens to wages. I think there will be some upward creep in wages. And this may now finally be happening in the UK, where wages have remained stagnant for some time.
The UK economy has defied expectations
The UK economy slowed last year, bucking the global trend. After growing by 1.9% the economy slowed to 1.8% in 2017. This year, I expect this growth rate to accelerate towards 2%, which is better than the consensus which expects only 1.5%. The outlook will depend upon the interaction between the fundamentals, policy and confidence.
The UK’s economic fundamentals point to a solid performance by manufacturers and exporters this year, helped by the strength of the world economy.
The fall in the pound following the June 2016 Referendum has also helped improve competitiveness. I thought a weaker pound was good news, and was long overdue. It was also needed to rebalance the economy as the UK has a large trade deficit. Now the pound has reversed some of its post referendum fall as the economy has performed better than some feared and it appears likely that a trade deal will be agreed between the EU and UK later this year.
Confidence is key
Much will depend upon confidence – not just of households but of businesses, too, who appear to remain worried by the uncertainty surrounding Brexit. What matters is not just about leaving the EU but what you do once you leave, and thus attention will focus in coming months on the policy proposals unveiled.
Another factor that should help the British economy this year is consumer spending. Last year this suffered as inflation rose sharply. Now inflation is decelerating, having fallen to 2.7% in February from its November peak of 3.1%, and I expect this to continue. Meanwhile, the tight labour market, where employment is at an all-time high, is leading to faster wage growth. As a result, by the second half of this year, wage growth should be outstripping inflation, boosting spending power.
Overall, the release of first quarter UK GDP figures (with preliminary figures on 27th April) will likely show a dampening impact from the bad weather. But as we move through coming quarters it will be trade negotiations, business confidence and consumer spending power that will help determine how resilient the UK economy is.
That resilience has been tested so far in the face of Brexit negotiations. There will be further stresses for the economy and markets in coming months, as the focus on Brexit talks may be joined by increased worries about a global trade war and global and UK monetary tightening.