Subdued Global Growth and Flat Inflation Confront Central Banks

Mon, Sep 12, 2016 - 8:53am

The European Central Bank (ECB) met on September 8. The US Federal Reserve Bank’s Federal Open Market Committee (FOMC) meets on September 21, and the Bank of Japan (BOJ) holds its next Monetary Policy Meeting on September 20–21. To varying degrees these key central banks face sluggish economic growth, with current and projected inflation levels that languish far below stated objectives, despite extended periods of massive quantitative easing and policy interest rates near or below zero. Markets nervously await the banks’ next moves.

The latest indicators of economic performance suggest that momentum, which was sluggish through the summer months, has slowed further. The OECD’s leading indicators now point to stable growth at a slow rate. The JPMorgan Global/Markit Purchasing Managers’ Index (PMI) global economy readings for July and August together indicate that the global economy is stuck in “the slowest growth phase for over three years.” A decline in the August PMI for the US suggests third-quarter GDP growth may be close to 1%, contrary to earlier projections of 2+%. The Nikkei Japan PMI also declined in August, signaling continuing stagnation in the Japanese economy.

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For the current year, GDP growth in the US now appears likely to be only about 1.5% (as opposed to last year’s 2.6% advance), with 2.3% expected in 2017. The ECB now projects the euro area’s growth at 1.7% this year, easing to 1.6% in 2017. Japan’s GDP growth this year looks likely to be similar to last year’s 0.5% but is projected to be somewhat faster next year, approaching 1%. While the risk of recession in these advanced economies is low, their performance is not sufficient to lift the pace of inflation to the levels sought by central banks. The advance in the US Consumer Price Index is projected to be 1.2% this year, possibly rising to 2.2% next year. In the eurozone the advance is projected by the ECB to be only 0.2% this year and 1.7% in 2017. In Japan consumer prices appear likely to register a decline of 0.3% this year and perhaps to pick up to a still-too-modest 0.7% next year.

On the other hand, emerging-market economies, led by China, India, and Russia, are experiencing their strongest expansion in one and a half years, although still well below historical rates. Emerging-market GDP growth is on a course to advance by 4.4% this year and by over 5% in 2017. A limiting factor has been the slow pace of world trade growth, projected by the World Trade Organization (WTO) to match last year’s 2.8% pace in 2016. The WTO expects world trade to quicken to a 3.7% rate next year; but in view of our current economic forecasts, an advance over this year’s pace is looking increasingly unlikely. The political countercurrents to trade liberalization are a serious concern. Prospects for successful completion of the Trans-Pacific Trade and Investment Partnership negotiation look slim, and nothing is moving in the DOHA round of multilateral trade negotiations. There is a risk of a significant rise in protectionist measures in the years ahead. Emerging markets would be seriously affected by such a development.

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The ECB was the first of the three major central banks to meet this month. No major policy moves were expected at this time, and indeed the bank took no action other than to ask several internal committees to evaluate the design of present ECB policies to possibly broaden the pool of eligible assets for purchase, acknowledging that the bank could encounter a scarcity of bonds to buy under the present policies. The ECB’s president, Mario Draghi, offered his evaluation that the existing monetary policy stance is “fully effective” and the transmission mechanism is working well. It is true that bank lending standards are easing and loan demand is increasing. He said that the present lackluster eurozone growth projections, which were slightly reduced for 2017 and 2018, “were not so substantial [as] to warrant a decision to act” and observed that there was no increased risk of deflation. We would add that the slow growth is above estimates of the eurozone’s potential growth. Yet he acknowledged that economic risks remain on the contractionary side. He stressed that there is “no question about the will to act and the ability to do so.” While the ECB decided not to act at last week’s meeting, further monetary stimulus action does appear to be required. The December meeting of the ECB is the most likely timing for such action, depending on the next revision of the ECB’s economic projections and the results of the staff’s analysis of the current policy stance. At a minimum, an extension of the quantitative easing program beyond the current end date of next March looks necessary, along with some broadening of the pool of eligible assets.

Attention now turns to the Federal Reserve and BOJ meetings in two weeks. The BOJ has the strongest reasons to take action, with a stagnant economy shackled by continuing disinflation, despite negative interest rates and a quantitative easing program that, relative to GDP, is far more aggressive than those of the US or the eurozone. But one has to wonder whether more of the same would finally do the trick. Movement on needed economic reforms and implementation of promised fiscal stimulus look essential to get Japanese businesses and consumers to increase their spending. The same comment is relevant for the eurozone.

The situation for the Federal Reserve is different, as FOMC members appear to be looking for an opportunity to increase policy interest rates. But slow economic growth in the third quarter, job-market data that is not as strong as it appears on the surface, and little threat of strengthening inflation suggest to this writer that December is a more likely date for the next rate move. Markets may prove volatile, as we saw last Friday, in the uncertain period leading up to these central bank meetings.

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Chief Global Economist
bill [dot] witherell [at] cumber [dot] com ()