Over the last few months, global equity markets have been driven by encouraging corporate earnings results, an outline of Donald Trump’s tax reform proposals and geopolitical developments in Syria, North Korea and Europe. The global economy is also expanding, with signs of inflation.
The election of Emmanuel Macron, as President of France, has removed some risk within Europe. His reformist agenda and commitment to the European project are seen as supporting the ongoing European recovery. However, there remains some political risk in that France has a Parliamentary Election, at the beginning of June. Traditionally the French electorate have supported the French President, however, Emmanuel Macron’s political movement, En Marche! was launched a year ago and has no MPs. It is possible that Emmanuel Macron could be a weak President.
Looking beyond the political risk, there have been improvements in the European economy. The Eurozone composite Purchasing Managers’ Index (PMI) has accelerated at its fastest pace in 6 years to 56.8, in April, from 56.4 in March.
The German economy grew 0.6% in the first quarter of 2017, which is faster than the fourth quarter of 2016, which was 0.4%. Strong household and state spending, together with firms investing in construction and equipment, drove the economy.
The improving economy in the Eurozone should mean that the European Central Bank could start to remove the existing monetary policy stimulus.
Although there have been improvements within the European economy, Greece remains an issue. Greece is due to make a large debt repayment in July and requires a 7 billion Euro bailout. Greece, the EU and International Monetary Fund (IMF) have struck a deal to implement a package of 140 separate economic reforms, in return for a new round of aid from the European Stability Mechanism bailout fund.
The Bank of England has trimmed their forecast for UK economic growth to 1.9%, in 2017, down from 2% in its February forecast. The slight downgrade has been driven by a slowdown in consumer spending. Although the UK is experiencing a slight slowdown, the economy should still grow at a faster rate than in 2016, when the economy expanded by 1.8%.
The Bank of England’s Monetary Policy Committee (MPC) has voted to maintain interest rates at 0.25%; however, the MPC warned that the fall in the value of the pound, since the Brexit vote, is likely to push real post tax household income growth to zero this year. The Bank of England has also cut its forecast for wage growth to 2% this year, from a previous forecast of 3%. This represents the biggest squeeze on incomes in 4 years.
Inflation, as measured by the Consumer Prices Index (CPI), has risen to 2.7% in April, from 2.3% in March. The Bank of England is forecasting that CPI will peak just below 3% this year, before easing gradually to 2.2% in 2019.
The Bank of England Governor, Mark Carney, stressed it is important to put the squeeze on incomes, in context. Mark Carney said that, “The context is the economy is still growing solidly, the economy is still creating jobs, wages are still growing and we expect the pace of wage growth is going to accelerate as this year progresses and certainly into 2018 and 2019.” The unemployment rate is projected to drop to its lowest level since 1975 by the end of the decade, whilst consumer confidence remains steady.
The UK General Election could provide some uncertainty, however, this appears unlikely, because Theresa May is expected to win a big majority.
The US economy grew at its weakest rate in 3 years, with first quarter Gross Domestic Product (GDP) growing at 0.7%. This was attributed to auto-sales and lower home-heating bills, which dragged down consumer spending, offsetting a pickup in investment led by housing and oil drilling, which underpinned the recovery in oil-shale production. The slowdown was reflected in the seasonally adjusted Markit Flash US Composite PMI, which fell to 52.8 in April, from 53.3 in March. Despite this moderation in growth, the Federal Reserve’s (Fed) long-term outlook is for positive growth, rising inflation and eventually a tighter monetary policy. Unemployment levels have fallen to 4.5%, which is the lowest level since 2007.
The Fed has revealed its intention to start to unwind its sizeable $4.5 trillion balance sheet, later this year. Unwinding the balance sheet should not necessarily affect markets, but it is in effect, what amounts to the Fed tightening monetary policy.
Donald Trump’s political troubles in Washington could delay or even prevent his proposed tax reforms and infrastructure spending from being implemented. This political uncertainty will have short and long-term implications for both the economy and markets.
Japan’s macroeconomic data has been stable. The Consumer Confidence Index has risen to its highest level since the launch of Prime Minister Shinzo Abe’s economic policy of “Abenomics”. The unemployment rate has also fallen to a 22 year low. Against this backdrop, the Bank of Japan views the current economic growth as a period of “moderate expansion”, and should retain its ultra-loose monetary policy.
The two most important developing economies, China and India are continuing to show strong growth, however, China’s rate of growth is slowing.
China’s economic growth is expected to slow to 6.5% in 2017, despite a strong start to the first quarter of 2017. The Chinese Government seeks to cool the property sector and credit growth, with the aim to contain the risks from the significant increase in debt. A Reuters’ poll of 75 economists is indicating that growth in 2018, is expected to weaken further to 6.2%. This extends the slowing trajectory for the world’s second-largest economy. The Chinese economy grew 6.7% in 2016, which was the worst performance in 26 years. Industrial production also confirms a slowdown, only growing 6.5%, year on year to April, having previously been 7.6%, a month earlier.
Unlike China, India’s economy is continuing to strengthen. The Federation of Indian Chambers of Commerce and Industry’s latest Economic Survey has forecast GDP growth at 7.4%, for the financial year, 2017-18. The pick-up in overall GDP growth will be supported by an improvement in industry and services sector growth. The IMF said that it is too soon to determine what the impact of demonetisation (i.e. the removal of 500 and 1000 Rupee banknotes) will be on the Indian economy; however, India should continue to benefit from Prime Minister Narendra Modi’s reform agenda.
Russia and Saudi Arabia have agreed that the cut in oil production should be extended to March next year. A barrel of Brent Crude has risen to $52.25. The two energy ministers from Saudi Arabia and Russia agreed, “To do whatever it takes to achieve the desired goal of stabilising the market and reducing commercial oil inventories to their 5-year average level”. Saudi Arabia and Russia produce 20 million barrels of crude oil a day – about one-fifth of global consumption and other oil-producing nations are expected to follow their lead over cuts. Rising oil prices should drive inflation higher; however, oil-shale production in the US may limit large upside to the price of oil.
The global economy is expanding, with signs of inflation in the system, which means that central banks are starting to look towards tightening their monetary policy. The US Fed is, not surprisingly, leading the process. The economic data within Europe, for the first time in years, is encouraging, although there remain some political risks, despite a positive result in the French Presidential Election. In the next few months, there is a Parliamentary Election in France and General Elections in the UK and Germany. The situation with Greece highlights the fact that the debt situation within the Eurozone has not been solved, with many countries, including Spain and Italy, experiencing serious debt problems. Perhaps the biggest risk is Donald Trump’s political problems in Washington, which are creating a number of economic and market uncertainties.