At the beginning of 2018, there was a distinct and welcome mood of optimism about the prospects for the global economy. IMF Chief Economist Maurice Obstfeld noted positive surprises in China and in advanced economies, including in Europe. He was by no means alone in framing a consensus articulated also by banks, global consulting firms and governments. Your scribe wasn’t so sure as you can see here, here, and here. As we approach the half-way stage of the year, the consensus has become rather more sober. Has a synchronised global recovery become a desynchronised and faltering expansion?
Some indicators of the health of the world economy have definitely raised a few eyebrows. The Baltic Dry Index, which reflects shipping activity, has fallen sharply this year following an erratic surge in 2016-2017. The International Air Traffic Association’s index of freight tonne kilometres, which reflects cargo volumes by weight and distance, was at its lowest level for two years in March.
Crude oil prices have been on a bit of a tear, with Brent crude, for example, rising from just over $60 a barrel at the start of the year to just under $80 a barrel. This probably reflects supply restrictions by Opec countries and Russia, and shortfalls in Venezuelan output, more than surging demand. Yet higher prices may dampen global demand, unless Opec agrees to tap (limited) unused capacity at its June meeting in Vienna.
Other barometers of the state of the global economy have also turned. Exports from South Korea—often a useful trade guide since the country is key in China’s and global supply chains—fell in April for the first time since late 2016. Chinese economic activity data has softened too, as I noted last week. The chillier relationship with the United States over trade, technology and investment also hangs as a dark cloud over Chinese and global growth prospects. Japanese GDP dropped by 0.6 per cent in the first quarter of the year, offsetting an equivalent rise in the previous quarter.
The major concern, though, has been Europe, about which there were high expectations after a solid performance in 2017. As we know, the UK has been the weakest economy, with growth sliding to just 1.2 per cent in the year to the first quarter, but the Euro Area has been softening too. Overall, growth was just 0.4 per cent early this year, just over half the rate of the prior quarter. The year over year rate was still 2.5 per cent, and some of the factors that may have contributed to slower momentum were one-offs, such as cold weather, strikes in France and Germany and a bad flu outbreak in Germany.
Yet hopes for a bit of a rebound in the April-June quarter should be tempered because more fundamental forces are at work too. The impact of the European Central Bank’s quantitative easing expansion from 2015-2017 is most likely fading now, and the buoyancy of growth in 2017 was in any case probably not sustainable. Now, growth is reverting to a slower underlying trend as supply limits re-assert themselves. The investment rebound in the recent past has been welcome but it’s still lower as a proportion of GDP than in 2007, and construction—heavily influenced by public investment programmes that have been pared for a decade—remains under pressure.
Looking ahead, trade tensions with the US now loom as a dampening influence on confidence, and politics are again stalking the economic outlook in the Euro Area. With the presidential veto of an anti-euro finance minister nominee, Italy’s two major populist parties have withdrawn their attempt to form a government, and the president has asked a former IMF official, Carlo Cottarelli, to form a temporary technocratic government. It is unclear if this will work, or for very long, and financial markets will have to price in continued unpredictability. Italian 10-year bond yields have already risen sharply in the last two weeks, with the difference over German bond yields—a measure of the risk premium—almost doubling.
The principal concern is that, sooner or later, a populist economic agenda will present Brussels, Berlin and Paris with a sort of Syriza 2.0 in the Euro Area’s third largest economy. Italy has a banking system with the region’s highest non-performing loans, and complex connectivity issues with other European financial institutions. The quip that Italy is too big to fail and too big to save is no understatement. In addition, it emerged last week that the Spanish minority government of Mariano Rajoy’s People’s Party may fold and have to call new elections after only 17 months, following a court verdict in a corruption trial involving past PP officials.
Somewhere in this sea of uncertainty, there is still some optimism that the US economy, which grew by 2.9 per cent in the year to the first quarter, is on course for 3 per cent growth this year. Buoyed by a tightening labour market, and the impact of the fall in corporate tax rates enacted early in 2018, including on capital spending, things still look relatively good, if you are willing to put Washington DC governance issues to one side. At the same time though, the US doesn’t seem to be accelerating any longer. The Federal Reserve has been gently tightening financial conditions (six interest rate rises since 2015), bond yields have risen erratically and the US dollar is strengthening.
The world economy still has forward momentum, but it has lost the synchronised and accelerating properties that encouraged so many at the turn of the year. It has become less a dynamic organism and more a curate’s egg. And we need to pay more attention to the bits that are not so good.
