Economic trends

Global growth: is this as good as it gets?

The global economy is in better shape than a year ago, but growth is still below pre-financial crisis levels

 

The world economy is heading into the year-end relatively strong. Growth is higher than in 2016. It is also higher than the averages seen since the global financial crisis (GFC). But we cannot celebrate. Not yet.

Growth is still below the levels we were enjoying before the GFC, and this recovery is cyclical in nature and therefore vulnerable. Structural challenges remain. Productivity growth is weak, especially in the West.

Geopolitical risk is high, and given the nature of domestic politics in the US, there is the added risk of a trade war. Debt levels are very high across developed and emerging economies, and they have increased since the GFC. As a result, there is little space for fiscal policy to deal with shocks. With global interest rates low, there is also limited space for monetary policy to deal with shocks.

Shocks can change this outlook. And shocks can be both positive and negative.

There is a risk that markets may have become too negative

The shocks – good and bad

US politics could be one source of shocks. Following Donald Trump’s election win there was euphoria in financial markets hoping for a US reflation. There was a strong expectation of a boom in infrastructure spending and fiscal stimulus. We, however, did not share the euphoria. We were highly doubtful of the administration’s ability to implement such a policy. Since then, markets have started to share our view. The US dollar has surrendered its post-election gains, and political paralysis in the US has lowered expectations of meaningful stimulus.

But there is a risk that markets may have become too negative. In particular, there is a possibility that Trump and the US Congress could agree on some type of tax reform, providing the economy with fiscal stimulus. If that materialises, markets can be positively surprised. And although that surprise could strengthen the US dollar, its impact on the economy would still be limited.

First, because the economy is operating more or less at full capacity and a stimulus is unlikely to push it much further. And second, tax cuts, particularly for the highest earners who have a smaller propensity to spend, will not be as effective in supporting growth as investment in infrastructure.

Geopolitics could be another shock and this time, a negative one. Developments in North Korea are in focus, and risks are elevated. Thinking rationally, one should not expect these tensions to escalate into a military confrontation. But rationality does not always prevail when the human factor is involved. The main risks are political miscommunication or miscalculation.

The main shock – policy changes

But perhaps the main shock could come from policy changes, particularly in the US. Easy monetary policy is one of the key factors driving economic growth. Given our view that this recovery is cyclical in nature and that structural challenges remain, the monetary policy outlook will be key in determining the recovery’s sustainability.

China’s policy is tightening, going from accommodating to neutral. But the Chinese authorities will be keen not to jeopardise their growth trajectory. China’s President Xi is likely to reiterate the goal of doubling the country’s 2010 GDP by 2020 at the Party Congress in October. To achieve this, China has to maintain a minimum growth rate of 6.3 per cent from 2018-20. As a result, the authorities will want to ensure that policy is not tightened aggressively enough to derail growth. So China should not be the main problem.

 Wages could begin to rise more rapidly

Meanwhile, in the US, the Federal Reserve’s (Fed) decisions have a significant impact on the world economy given their effect on global liquidity. We expect the Fed to follow a very gradual hiking trajectory, supporting the global economic environment. But there is a risk that wages (and consequently inflation) could begin to rise more rapidly, as in previous cycles. Early signs of such dynamics could lead to more aggressive Fed hikes.

Is ‘as good as it gets’ enough?

Expect the world economy to end 2017 and start 2018 with good momentum, despite ongoing structural challenges. This cyclical recovery will likely depend heavily on a continuation of relatively loose monetary policy, particularly from the Fed and the European Central Bank. Policy shocks are a risk, perhaps not so much in the next three-to-six months, but they could become more of a concern later in 2018.

So is this as good as it gets? In the absence of structural improvements and with the risks of shocks possibly yes. Plus, given that we are still below our pre-crisis global growth levels, as good as it gets is definitely not good enough.

 

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