The Organisation for Economic Cooperation and Development (OECD), in their twice-yearly Economic Outlook, are forecasting that global growth will accelerate from 2.9% to 3.3% in 2017 and reach 3.6% in 2018. This increase is on the prospect of US President Elect, Donald Trump, implementing tax cuts and increasing public spending.
The OECD has increased their US economic growth from 2.1% to 2.3% in 2017 and expects US growth to reach 3% in 2018, the highest rate since 2005. The unemployment rate is projected to decline from 4.9% this year to 4.5% in 2018. As the US labour market becomes tighter and wages rise, the OECD forecast that inflation will increase from 1.2% in 2016 to 2.2% in 2018, prompting the Federal Reserve (Fed) to raise interest rates gradually to 2%.
Although the economic growth upgrade is positive, it must be remembered that the US political system has built in checks and balances and there is uncertainty about what policies Donald Trump will be able to implement. A Republican controlled Congress may approve tax cuts; however, a Republican controlled Congress will probably not approve unfunded public spending.
Turning attention to actual growth, during the 3rd quarter this year, the US economy grew at an annualised rate of 3.2%. This was due to an increase in consumer spending and a surge in soybean exports. This is the strongest growth since the 3rd quarter of 2014.
The Fed chairperson, Janet Yellen, has indicated that the Fed could raise interest rates “relatively soon”. She said that the job market had improved during 2016 and that inflation, while still below the Fed’s 2% target, had started to pick up. With indications that Donald Trump will cut taxes and increase public spending, the Fed will look to contain inflation by raising interest rates. Goldman Sachs’ subjective probability of the Fed raising interest rates in December is 90%. If interest rates rise, it will be only the second time the central bank has raised rates since 2006.
Turning to the UK, the new Chancellor, Philip Hammond, has announced his immediate plans in his Autumn Statement. The Government’s finances will not be in surplus by 2019/20, as previously targeted, but rather a return to balance “as soon as practical”. Debt is expected to peak at 90.2% of GDP in 2017/18. Given the uncertainty regarding Brexit, it is impossible to be precise on the economic impact. The level of indebtedness is not a disaster at this stage as fiscal rules are regularly changed and although high, it remains manageable.
Philip Hammond is looking to increase infrastructure spending with a new £23 billion infrastructure fund. There will also be a £2.3 billion housing infrastructure fund, with the aim to deliver 100,000 new homes in “areas of demand”. There is a plan to invest £1.1 billion in the transport networks.
Philip Hammond stated, “My priority as Chancellor is to ensure that Britain remains the number one destination for business – creating the investment, the jobs and the prosperity to protect our long-term future.” He aims to achieve this by continuing the policy of cutting corporation tax, which should fall from 20% to 17% by 2020.
Although there is greater emphasis on fiscal policy, the Government will also rely on monetary policy remaining accommodative to help finance borrowing.
The OECD has revised up its UK growth forecasts from 1.8% to 2% in 2016 and from 1% to 1.2% in 2017. The OECD concluded that Brexit should have less of an impact than initially thought. Although the forecast assumes that the UK will obtain the ‘most favoured’ status under the World Trade Organisation when it leaves the EU in 2019, the uncertainty surrounding the negotiations is a major downside risk.
Inflation, as measured by the Consumer Prices Index (CPI), rose 0.9% in the year to October 2016, compared with a rise of 1% in the year to September 2016. Although the rate was slightly lower than in September, it remained higher than the rates otherwise seen since late 2014. Rising inflation could affect consumer spending. In its quarterly inflation report, the Bank of England lifted its 2017/18 inflation forecast 100 basis points to around 3%, which is 1% above the Bank of England’s inflation target.
The main reason why inflation is expected to pick up in the UK is the weakness of Sterling, which has resulted in the price of imported goods rising. However, Sterling has staged a mini-recovery. Sterling has risen nearly 2% against the US Dollar over November and it is set to record its best monthly performance since January 2009. As at 29 November, Sterling is also 4.8% higher since the start of November on a trade-weighted basis and up 5.1% against the Euro, after hitting an all-time low in October. Sterling is benefiting from the political risk that is outside the UK, such as Donald Trump’s election victory in the US and the upcoming constitutional referendum in Italy.
The strong performance of Sterling follows 5 successive months of decline in the wake of the Brexit vote. Whether Sterling continues its recovery will depend on the UK implementing Article 50 and the resulting negotiations with the European Union, together with the increasing political risk in both the US and Europe.
The political uncertainty in the US and the UK could be exported to Europe. To start with, Italy is having a constitutional referendum on 4 December 2016. If the Prime Minister, Matteo Renzi, loses, it could undermine the nation’s fragile political stability and economy. Up to 8 banks may fail if Matteo Renzi resigns and his bank bailout programme is scrapped or not adequately replaced. There is a risk of contagion throughout the banking system within Europe.
Next year, there are general elections in France and Germany, which may also result in political change and/or uncertainty within these nations.
Although there are political uncertainties within the Eurozone, the economy is growing. In the 3rd quarter of 2016, the Eurozone grew by 1.6% on an annualised basis.
The OECD has revised up its economic growth forecast for Japan from 0.6% to 0.8% for this year, and to 1% from 0.7%, in 2017.
In recent years, China has exported deflation around the world. However, last month China reported its first producer price inflation since early 2012. This supports the trend of rising global inflation, although it must be reiterated inflation is at extremely low levels and is not yet a serious issue.
The Chinese economy is expected to continue its slowdown with the OECD expecting economic growth in China to slow from 6.7% this year, to 6.4% in 2017.
Brent crude has increased to over $50 per barrel on the announcement that OPEC has finally agreed cuts in oil production.
Donald Trump is due to take up his new position, as US President on 20 January 2017. His election signals a period of change and could have a dramatic impact on global growth and inflation. There should be a time lag before the exact impact is known and there is significant uncertainty for the simple reason that no one is sure what policies the President Elect will implement. Political uncertainty that started with Brexit and continued with Donald Trump’s election victory will probably move to Europe and will be a continuing theme in 2017.