Global Economic Outlook Q3 2019

The global economy continues to falter as the trade war between the US and China intensifies. With few signs of an imminent easing in tensions we expect global growth to dip to its lowest rate in a decade, before flatlining at anaemic levels over the course of our forecast horizon. Even these gloomy expectations are contingent on proactive central bank policy support, and no further significant escalation on the trade front. If we are wrong on either count, the global economy could be staring down the barrel of a recession.

Trade tensions exploded over the summer. President Trump announced a plan to raise existing tariff rates, and add these levies to virtually all Chinese trade by the end of the year. These steps will nearly double the average tariff rate on Chinese imports. While a fresh round of talks are scheduled for October, we are sceptical that a deal can be reached to bridge the significant differences between both parties. Instead, we expect the measures announced to be delivered, with the risk tilted towards additional escalation.

The manufacturing sector has been the most obvious casualty in this dispute. Global trade volumes and manufacturing production have slumped, with forward-looking indicators suggesting further weakness to come. The more domestically-orientated services sector has thus far been more resilient, although we have started to see tentative signs that momentum is starting to falter a little. Overall, our macro momentum and nowcast indicators all point towards subdued near-term momentum in the global economy.

The combination of an escalating trade spat and weaker near-term activity has prompted further downward revisions to our forecasts. We now expect the global economy to slow to 2.8% this year – the weakest outcome since 2009. Thereafter, we see few prospects for a rebound in activity, with global GDP expected to hover around these levels in 2020 and 2021. In total this represents a 0.7 percentage point downgrade to our expectations last quarter, and puts us around 0.5 percentage points below consensus.

The downward adjustments have been broad-based, reflecting the wide reaching impact of trade tensions. The UK catches the eye, with a sharp recession next year the result of hard Brexit becoming our baseline assumption. Elsewhere, US growth rates are expected to halve from 2.2% this year to 1.1% in 2020 as tariff measures ratchet up alongside a fading fiscal impulse. In the open Eurozone and Japanese economies we expect growth to slip further below trend.

In emerging markets (EM), we have cut our expectations for growth in China as it feels the brunt of trade aggression and its more restrained policy easing cycle continues to deliver disappointing results. Elsewhere, we have become more cautious on the scale of the bounce back in some of the other major EM economies over the next 12 months against the backdrop of weak global growth.

Fewer changes have been made to the inflation outlook, with underlying inflation still undershooting target in most developed market economies. This familiar refrain reflects the muted passthrough from tighter labour markets to domestic price pressures. Indeed, in those economies which are seeing faster wage growth, the brunt of this is still being borne by increasingly stressed corporate margins. On balance, slower activity is likely to provide an additional weight on underlying inflationary pressures across economies.

The subdued inflation backdrop provides ample room for central banks to offer more support. We now expect the US Federal Reserve (Fed) to cut rates at every meeting this year, the European Central Bank and Bank of England to deliver a combination of rate cuts and asset purchases, and other major central banks to shift in a more supportive direction. Elsewhere, Chinese policy rates and the reserve requirement ratio will need to adjust further and the Renminbi will also depreciate further if the trade war escalates. In Brazil, India and Russia weak growth and below target inflation mean further cuts are likely over the coming quarters. Critically, these steps are only expected to cushion the slowdown in activity, rather than deliver a rebound in growth.

Despite the large downgrades we continue to believe that risks are tilted to the downside. This is perhaps most apparent on the trade front. We will need to watch closely that the escalation incorporated into our base case does not derail labour market conditions, which in turn would undermine the services sector. Moreover, our updated scenarios on trade policy highlight a sizeable risk of further escalation, which would deliver a blow to the global economy that central banks might not be able to combat.

Risks are not entirely to the downside. A trade deal between the US and China would lift some (but not all) of the uncertainty for firms. Moreover, it is possible that the magnitude of monetary stimulus, or its efficacy, surprises to the upside. Finally a broad based easing of fiscal policy would provide a significant impetus to global growth, but we would question the willingness of policymakers to deliver such a bold step.

 

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