Is the global economy heading for a recession? That is the big worry for financial markets. Equity markets have become more volatile and now a significant proportion of global government debt has negative yields.
From the middle of 2016 until the first half of last year the world economy grew strongly and at a faster pace than in the years before. A combination of factors explained this, including an acceleration in the US, helped by President Trump’s tax cuts.
However, since last summer the world economy has slowed. As a result, bond markets now fear a global recession, or at the very least expect significant interest rate cuts across the world to prevent this.
Indeed, during the first half of this year, well over 30 central banks (including the US in July) – in countries accounting for more than half of the world economy – have lowered rates. This is a major U-turn from recent years and includes the US, who only last December were raising interest rates.
Judging from the financial markets, there is now the expectation of further monetary easing across a host of countries, including the US and a prolonged period of low rates in Europe. This mirrors the experience of Japan, where rates have been close to zero for a couple of decades.
Weak data and trade disputes
Recent data in the euro area is disappointing, particularly in Germany where industrial output has weakened significantly. Manufacturing is slumping across the globe, also not helped by problems facing the worldwide auto industry.
The escalating trade war between the US and China is the main global worry. As the IMF says, “Consumers in the US and China are unequivocally the losers from trade tensions”. But not only is its escalation likely to dampen growth in the US and China but there will be wider contagion, as it dampens global demand, slows trade, adds to uncertainty and disrupts global supply chains.
The Chinese currency has also recently depreciated, prompting criticism from the US of currency manipulation. If there is a prolonged, significant depreciation it will exacerbate global competitive pressures, squeeze pricing power and keep global inflation low.
Given the damaging economic implications, one might expect the most likely outcome to be a resolution to the US-China trade dispute. However, geopolitics may prevent this.
Additionally, there is also a trade dispute between South Korea and Japan and uncertainty over the future UK-EU trade relationship, too. Thus, in this environment, many international investors have become more risk averse, with safe haven assets benefiting, as bonds rally and equities coming under pressure.
UK growth is muted, yet defiant
The UK has also slowed significantly, following a strong first quarter of the year, in which growth was artificially boosted by stockpiling ahead of a possible end of March Brexit. The economy grew 0.5% in the first quarter. Despite this slowdown, the UK economy has continued to defy the pessimists.
In the eleven quarters of GDP growth that have been released since the 2016 Referendum, the UK economy has averaged 0.43% growth each quarter, although this was in a period of strong global growth. Just for comparison, the average for the UK was 0.67% in the eleven quarters before the referendum. Since the Referendum, uncertainty has weighed on investment plans, although in contrast the economy’s openness and flexibility has continued to generate jobs, with one million added since the 2016 Referendum.
The UK faces increased political uncertainty ahead of the end of October. Opinions are divided as to whether the UK and EU will agree to proceed to the next stage of trade talks, or whether the UK will leave without a deal. To this is added continued speculation about a possible general election.
It is interesting to consider these challenges in the context of the pound’s fall. Sterling was already at a competitive level but currency markets can overshoot and have pushed it weaker. It is now incredibly competitive and this will likely boost inward investment once uncertainty is removed.
But it cannot divert attention from the need for the UK, in the new global economy, to compete more on quality. We already do so in many areas, such as high-end manufacturing and FinTech.
Extra factors to consider
Yet it is not just the current global picture that is relevant for assessing UK prospects now. This potential, and indeed the outlook elsewhere, needs to be put in the context of two longer-term factors: the 2008 global financial crisis and the shift in the balance of power from the west to the rest of the world, led by China.
The latter, through globalisation as well as new technology, has contributed to constrained wage growth here and elsewhere in the west. But now, as our unemployment hits a 44-year low, wages are rising, underpinning consumption, as the Bank of England’s recent Inflation Report alluded to.
One legacy of the global financial crisis has been cheap money, with low rates, and central banks having boosted their balance sheets by buying financial assets, such as government and corporate bonds in the UK.
This global trend may have fed asset price inflation in financial markets but it has also triggered the worrying situation now whereby central banks – despite cutting rates – have less room for manoeuvre than they might like to ease policy and stimulate growth. Hence, there is now also a renewed recent focus, in the UK and elsewhere, on the scope for using fiscal policy, through higher targeted government spending and tax cuts, to stimulate growth.
Overall, macroeconomic policy is set to come to the world economy’s rescue, and should allow growth to stabilise and prevent recession. However, it is the geopolitical risks on trade, particularly between the US and China, that need to be resolved to remove the downside risks.
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