Report2 March 2018Updated 10 months ago

Economic update: Still pumping…

Global economic growth is going from strength to strength and price pressures are building. Yet central banks in aggregate are still ‘printing money’ and fiscal policy is increasingly stimulative. This suggests global activity is subject to upside risk and the potential for an old style ‘boom-bust’ cycle may be rising. Central banks will need to tread carefully and markets should prepare for potentially unexpectedly sharp changes in monetary policy.

Executive summary

The US economic data for the start of 2018 has been hit by bad weather, but with confidence, incomes and profits at such high levels we remain very upbeat on growth prospects. Tax cuts, looser fiscal policy and infrastructure investment offer further support, but they also add to the threat of a sharper pick-up in inflation and a more rapid rises in interest rates by the Federal Reserve.

We may also hear more concern over the US twin deficits with the government set to borrow a net $1 trillion next year while the strong consumer sector will continue to suck in imports. We are a little more relaxed on the trade deficit given rising domestic oil output and stronger export demand. However, protectionist policies from President Trump will only intensify market wariness.

Recent data seem to suggest that Eurozone growth has now reached maximum speed and that the second half of the year might see somewhat slower, albeit still above-potential growth. Although some members of the European Central Bank (ECB) Governing Council have been pleading to drop the easing bias in its monetary policy statement that is unlikely to happen in the short run. Inflation is still going nowhere, while political uncertainty in Italy might push the ECB to tread carefully in determining its exit strategy.

The UK government has finally managed to craft a ‘Brexit’ compromise that ministers can rally around. But the proposals have been met with a cold reception in Brussels, with negotiators viewing the plan as an attempt to “cherry-pick.” Meanwhile, pressure is building on the Prime Minister to look more closely at a customs union as fears about a hard border with Ireland come back to the fore.

Japan’s inflation has risen to levels last seen following consumption tax hikes, with the next tax hike not due until April next year. Collapsing Pacific fish stocks and rising seafood prices, coupled with higher wholesale LNG gas prices are the driving forces. Neither look likely to disappear any time soon. The Bank of Japan (BOJ) may choose not to respond by reducing the pace of its asset buying, but there are other good reasons for it to consider doing so.

President Xi’s longer tenure means stability for the Chinese economy and continuity in economic policies. Foreign countries could feel the heat but that does not necessarily mean trade wars – although US steel and aluminium tariffs increase the risks. The new central bank governor will likely share Xi’s view of a gradualist reform approach. We revise our rate hike predictions to four, matching the US view, and keep our FX forecasts unchanged at 6.1.

FX markets are still coming to terms with the emerging themes of a weaker dollar and a potential rise in asset market volatility – exacerbated by the escalation in US protectionism. The Eurozone’s current account surplus (equivalent to 3.5% of its GDP) should provide good insulation to EUR/USD and we retain a 1.30 year-end target.