Global economic momentum remains strong…
The global economy is enjoying fairly strong momentum. The expansion is synchronised across different regions: euro area real GDP, for example, grew at its fastest pace since 2011; in the US, uncertainty about the policy outlook has so far not undermined investor and consumer sentiment, which remains at multi-year highs. Even in China, economic growth has held up surprisingly well, despite signs of a slowdown earlier this year amid a tightening of credit standards in the real estate sector. Large commodity-producing emerging markets such as Russia and Brazil, which were badly hit by the fall in commodity prices, are getting back on their feet. Private consumption is currently the main driver of the global recovery following a sharp reduction in unemployment rates and higher real wage growth in many countries. There are also signs that private investment is picking up, aided by increasing capacity constraints, low global interest rates and a solid global economic outlook. The solid momentum in the world economy is boosting global trade.
…as a result, we raise our forecast for the global economy
In light of the stronger-than-expected momentum in the world economy, over the past couple of months we have raised our global growth forecasts. We now expect the world economy to expand by 3.6% in 2017 and 2018 (almost half a percentage point higher than in June). While we are slightly more positive on US growth in 2018, the main upward revisions stem from the euro area, Japan and, to some degree, China:
The momentum in the euro area economy is particularly strong due to strong domestic and external demand. The somewhat slower growth in 2018 is a combination of moderation in private consumption and weaker contribution from net exports due to EUR strength and slowing growth in key export market China.
In the US, we have revised up our forecast for 2018 due to strong underlying growth. We are still sceptical about a fiscal boost from tax reform or infrastructure spending given the divisions in the Republican Party (see our flash comment on the tax reform: Still a long way to go for tax reform, 28 September 2017). The approval of tax reform would, therefore, offer upside to our forecast. We do not expect the weaker USD to have a material impact on net exports given the fairly closed nature of the US economy and a large part of the US trade being quoted in USD.
In China, we have lifted our real GDP forecasts for both 2017 and 2018 (by about 0.3pp compared with our June forecast). However, we still see slower growth next year as we expect the housing market to cool, spilling over to weaker construction growth. However, we do not expect a hard landing, as housing inventories are fairly low (in contrast to 2014) and the export sector should experience robust growth as the US and euro area recovery looks set to continue.
In Japan, we expect growth to continue through fiscal year 2017 raising the annual real GDP growth estimate to 1.7% (vs. 1.2% in June), supported by a strong labour market, the global economic recovery and extremely accommodative policies. As fiscal stimulus wanes next year, we would expect growth rates to fall closer to potential with real GDP growing about 1.4%.
Inflation pressures to remain modest…
Despite the solid economic growth and low unemployment rates in many countries, global inflation pressures remain muted. After rising sharply in 2016, inflation generally fell back in the first half of 2017. Oil prices drive most of the swings in inflation, and with prices no longer moving much higher from here, we expect the impact on inflation to ease. The outlook for underlying inflation is still muted; we expect core inflation to remain below 2% in the US and (particularly) the euro area until at least 2018. One of the reasons is continuing low wage pressures even in countries where little slack is left in the economy, such as the US and Germany; probably as inflation expectations have come down over the past few years. Another reason is easing inflation in emerging markets, where it is at the lowest level ever. A possible slowdown in China could weigh on global inflation through weaker commodity prices
…preventing central banks from pulling the emergency brake for the time being
With the modest inflation outlook, we expect the major central banks to only gradually remove the massive monetary stimulus put in place since the financial crisis. The Fed has raised rates three times so far and we expect it to raise rates another three times over the next year, with the next rate hike expected in December. Still this marks a relatively gradual hiking cycle compared with the past. Furthermore, the Fed is set to start a modest reduction of its balance sheet in October 2017, gathering pace in 2018, while the ECB is set to continue its QE purchases going into next year, albeit at a reduced pace of EUR40bn per month, keeping policy rates unchanged at least until 2019. Meanwhile, we expect the BOJ to continue its highly accommodative policies for a considerable time as inflation pressures remain muted compared with the central bank’s target. In light of the modest scaling back of central bank balance sheets, global liquidity is likely to remain ample for some time.
Base scenario supportive for equities and bearish for bonds
In light of the strong macroeconomic momentum, we remain positive on equities. We increase our overweight in developed market equities to 10%, as under the current positive macro conditions companies should be able to increase earnings through increasing sales growth. New investments should, at the same time, support cost cutting/efficiency gains, and thereby pave the way for continuous delivery of stronger earnings growth rates than in recent years. Naturally, strong global economic momentum tends to be bearish for fixed income. In addition, we expect somewhat higher yields in 2018. However, the muted inflation outlook, combined with modest tightening by the central banks, should keep a lid on the upward move.
Risk factors to watch
The risks to our growth forecasts are seen as broadly balanced. On the downside, the main risks to growth come from an unexpected sharp rise in inflation, triggering an abrupt tightening of monetary policies, a stronger-than-expected slowdown in China, a potential trade war and a military conflict with North Korea (which we see as a low probability-high impact event). On the upside, there is a possibility of a more upbeat investment outlook than we forecast due to pent-up demand in Europe after many years of weak corporate spending and the approval of significant tax reform in the US raising the economy’s potential growth rate.
