UK: 2016, The Year Ahead For The Global Economy

Last Updated: 14 January 2016
Article by Ian Stewart

Most Read Contributor in UK, August 2017

It has not been a good start to the year for the global economy. Expectations for the pace of GDP growth are falling. The dominant themes in financial markets are volatility and uncertainty. The US S&P500 equity index fell 5% in the first four days of trading this year, its worst four-day opening in history. Most economists think global growth prospects are more likely to weaken than strengthen in coming months.

It is not hard to think of risks. Take your pick from: China's slowdown, emerging market turmoil, migration, Brexit, terrorism, the US Presidential election, North Korea, Syria, Iran vs. Saudi Arabia, NATO vs. Russia, tensions in the South China Sea...

The sharp decline in corporate risk appetite seen in the latest CFO Survey demonstrates that such uncertainties affect investment and hiring. Yet numerous other factors also shape growth. Some risks do not materialise (who is talking about the US debt ceiling now?). Moreover, the principal effect of geopolitical shocks, such as the migration crisis, terrorism or the Arab Spring, tends to be political, not economic.

In short, we need to distinguish between a whole host of things, economic and political, that could happen and what is most likely to happen to the global economy. So, standing back from the latest news headlines here are our six macroeconomic themes for 2016.

First, continued but unspectacular global growth. After a strong bounce-back from recession the pace of global activity slowed from 2012 under the weight of the euro crisis and a deceleration in emerging market activity. In the last four years growth rates for the global economy have been running at around 60% of pre-crisis levels – conforming to the notion of a slower growth "new normal". This year the global economy is likely to grow at similar rate, or perhaps a bit faster, than it did in 2015. Cheap money (China and the euro area are likely to undertake further monetary easing this year), falling unemployment and a bounce-back in the euro area and the weakest emerging economies should help.

Second, Chinese growth is likely to cool not collapse. In the years before the financial crisis the Chinese economy grew by an average of around 10.0% a year, fuelling asset prices and credit growth. The boom was phenomenal. Recent estimates suggest that China's construction boom used more cement in the three year period 2011-13 than the US did in the entire twentieth century. The authorities' responded by dampening investment spending and trying to shift to consumer-led growth. Today annual growth in Chinese real-estate investment stands at 1%, down from 37% in the summer of 2010. China probably posted GDP growth of about 7.0% in 2015 and seems likely to grow by around 6.5% this year, the slowest rate in 25 years – though still enough to account for about one third of global growth. Higher government spending and cuts in interest rates should prevent China's slowdown turning into a rout.

Third, economic prospects for the euro area are improving. The political discord prompted by the euro area and migration crises seems to have obscured the recovery in Europe's economy. Low inflation and cheap money have helped generate faster-than-expected growth in the last year. Greece is still in recession, but the other, previously recession-stricken peripheral economies, have bounced back. Spain and Ireland were among the fastest growing nations in the rich world in 2016. Sentiment among households and businesses in the euro area ended 2015 at the highest level in more than four years. A weak currency and the European Central Bank's programme of money printing should deliver euro area growth around the 1.6% mark this year.  

Fourth, growth in world trade will remain subdued. The 1980s and '90s were a period of rapid globalisation, with trade volumes growing at around twice the pace of world GDP growth. Trade is now growing roughly in line with GDP growth. The flagging pace of industrialisation in Asia, particularly China, has played a significant role. The financial crisis and recession has blunted the momentum of trade liberalisation, one of the big engines for growth in trade. Meanwhile high levels of risk aversion and uncertainty represent a continued dampener on trade.

Fifth, the Federal Reserve is likely to raise interest rates cautiously in 2016, with either one or two 25bp rate hikes. This will maintain the momentum of tightening started in December when the Fed raised interest rates for the first time in almost ten years. The expectation of higher US interest rates has significant implications for the global economy. It has helped pushed up the value of the dollar by almost 25% since 2012; further US rate rises this year may well take the dollar higher. Dollar strength has, in turn, knocked US exports and manufacturing, making America's recovery more dependent on consumer spending. Finally, emerging market economies have suffered huge outflows of capital as investors shift money to the US in anticipation of higher US interest rates. These outflows have knocked emerging market asset prices, investment and currencies.

Sixth, commodity prices will remain weak – boosting consumer spending in the West and dampening growth in emerging economies. The breakdown of OPEC pricing power, weak emerging market demand and soaring US shale oil production have knocked oil prices. The easing of sanctions on Iran should keep supply plentiful in 2016. The bubble in agricultural commodities and metals has also burst. The worst may be past for the commodity-dependent economies such as Russia, Brazil and South Africa but future growth prospects look poor. Cheap commodities are one reason why consumer spending is likely to drive growth in the West in 2016.

Growth will be de-synchronised across the world in 2016. The major sources of faster growth in the world economy are likely to be Europe and Japan among the advanced economies, and India, Indonesia and Mexico among emerging economies. Chinese growth is likely to continue its long-term deceleration and US activity is likely to stick around the 2.5% mark. The global recovery faces headwinds, but also some tailwinds - lower unemployment, low commodity prices and cheap money. Overall our hunch is that the global economy will do a little bit better than it did last year. That would leave growth rates running well below pre-crisis levels, especially in the euro area and emerging markets. But it would, at least, confound the fears of the pessimists.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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