For over 18 months, since the outbreak of US/China trade tensions, global economic growth has been weakening, slowly but surely. In May 2018, the Organisation for Economic Cooperation and Development (OECD), along with other organisations, was predicting global economic growth of around 4% for 2019, whereas current forecasts for growth are around 3%. As a sign of this trend, global foreign direct investment fell sharply in the first six months of 2019, by a fifth. The drop accelerated in the second quarter, with flows contracting 42%. Flows into the European Union (EU) were particularly weak, however, flows into China rose by 5%, which illustrates the increasing economic importance of China.
In the third quarter 2019, the US economy continued to expand, growing at an annualised pace of 1.9%. This was ahead of expectations, but slightly down from the 2% growth in the second quarter. Consumer spending has continued to support the economy together with increased government spending.
The slowdown in the US economy has led the Federal Reserve (Fed) to cut interest rates by 25 basis points for a third time this year and is now set in the range of 1.5% to 1.75%, which should continue to support the economy. The Fed has indicated there may be a pause in any further reduction in interest rates. The cut in US interest rates has highlighted that most central banks in the developed world have exhausted their monetary policy options and, therefore, in order to support their economies, governments may have to pursue expansionary fiscal policy, i.e. increase public spending.
Brexit uncertainty and the General Election
Over the last couple of years, the uncertainty surrounding Brexit has continued to dominate the UK economic environment and markets. There will be no change in this until at least the beginning of next year. The EU has allowed the UK to extend their membership of the EU beyond the 31 October deadline, whilst Boris Johnson has successfully called a General Election on 12 December. The General Election could lead to even more economic and political uncertainty.
Despite the uncertainty surrounding Brexit, the UK economy avoided recession by expanding 0.3% in the third quarter of the year. Year-on-year economic growth to the end of September, slowed to 1%, from 1.3% in the second quarter. This is the slowest annual rate of economic growth the UK economy has experienced in almost a decade. Although the UK has not entered a recession, it must be pointed out the economy contracted in both August and September, and it was the expansion in July that drove the economy in the whole of the third quarter.
Public sector spending will be a big issue in the forthcoming election with all the main parties making their case for increasing public expenditure. However, public sector borrowing has risen by a fifth, leaving the next government less room to ‘turn the page’ on austerity, as promised. Borrowing for the six months to September hit £40.3 billion, up £7.4 billion from the same period in 2018.
Stockpiling ahead of another (abandoned) Brexit deadline helped the UK manufacturing sector last month, although it continues to contract. The IHS Markit/CIPS UK Manufacturing Managers’ Index (PMI) rose to 49.6 from 48.3 in September, its highest level since April.
In the third quarter of 2019, Eurozone GDP growth was ahead of expectations, rising 0.2% on the previous quarter. Economists polled by Reuters had been expecting 0.1% growth for the quarter.
The trade war continues to weigh most heavily on the Eurozone, particularly in Germany, due to the region’s large dependence on international trade compared to its international counterparts. In October, German manufacturing PMI reported a 41.9 reading, up only 0.2 from the previous month. The labour market and consumers are feeling the effects of the slowdown.
In its last forward guidance, which was left unchanged, the European Central Bank (ECB) suggested that interest rates would remain at their current or lower levels until inflation picked up. The ECB forecast economic growth for the Eurozone at 1.1% this year, and 1.2% in 2020.
Christine Lagarde, former head of the International Monetary Fund, has taken over from Mario Draghi as ECB President. Lagarde inherits an ECB tool kit that is nearing its limits, with interest rates at -0.5% and Quantitative Easing of €20 billion per month, until the inflation target of 2%, as measured by the Consumer Price Index, is close to being achieved. The challenge will be whether Lagarde can convince governments to pursue an expansionary fiscal policy, which will stimulate the economy.
The current economic cycle is over 10 years old and appears to be never-ending. One of the characteristics of this cycle is that there has been slower growth than in previous cycles, therefore, the global economy has always been closer to the edge of recession and the risk of a severe slowdown. It is too early to say whether the economic slowdown will lead to a recession in the developed economies, but in order to support their economies, the only option available is for governments to pursue an expansionary fiscal policy, as their central banks have very little ammunition left in their monetary policy armoury.