From great to good

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The IMF World Economic Outlook was released last week, projecting an ongoing global economic recovery. World GDP growth was forecast at 3.9% for 2018 and 2019, the strongest since 2011, and at 2.5% and 2.2% for advanced economies.  And out to 2023, world GDP growth rates of above 3.7% are forecast, supported by emerging market growth of around 5% that offsets slowing growth in advanced economies (down to 1.5% by 2023).

After several years in which successive IMF forecasts of world GDP growth were regularly marked down, the near-term growth outlook has been upgraded from the last full World Economic Outlook in October (although the upgraded forecasts relate mainly to the front of the period, with little change at the back of the forecast period).  And the IMF rightly warns on downside risks, including the potential for trade conflict and risks associated with monetary policy normalisation. 

This is a generally encouraging outlook. But these forecasts arrive at a time when there are signs that the acceleration in global growth is softening, particularly in Europe.  Is the ground shifting under these forecasts?  The portfolio of small advanced economies provides useful insights into how this might play out; small economies are a good barometer of the global economic outlook because of their deep external exposure.

Unsurprisingly, given the economic recovery process, the IMF marked up forecasts for small economy GDP growth.  Relative to the October 2017 World Economic Outlook, small advanced economy are expected to grow about half a percentage point faster in 2018 and 2019 and about 35bp faster in 2020.  In contrast, larger advanced economy growth was upgraded by just 10bp, 30b and 25bp for the next three years. 

With only a few minor exceptions, such as in New Zealand, GDP growth for 2018 and 2019 is expected to be higher across the small advanced economies than expected in the October 2017 Outlook.  And for countries like Switzerland, the Netherlands and Austria, these growth upgrades were significant.

Small advanced economies are expected to retain their overall growth performance edge, averaging GDP growth rates 0.5% higher than larger advanced economies through to 2023.  This is consistent with a strong global economy: indeed, the IMF forecast world trade growth to remain above 4% through 2020.  The sustained out-performance of small advanced economies is stronger when the global economy (and global trade) is growing well.

But the recent small economy data suggest that some caution should be exercised with respect to the strength of the global economic outlook.  Small economy GDP growth rates in Q4 2017 (2.8%) were down a little on Q3 growth rates (3.1%), as the external impulse from the second half of 2016 faded.  And this slower small economy GDP growth momentum looks to have continued into 2018. 

As one measure, small economy export growth continues to moderate after a strong acceleration from 2016.  Small economy export growth in the year to February was under 6% after being at around 10% in the middle of 2017.  This is particularly pronounced in Asia, where export growth has – until recently – been very strong.  For example, export growth to China from Asian small economies has been slowing over the past several months, from 20%+ growth rates in mid-2017 to under 7% in March. 

And across the small economy group, from Europe to Asia, PMI readings are coming off (albeit from very high levels), various lead indicator measures seem to have peaked, and measures of business confidence have softened slightly.  However, these numbers are still healthy, and there are some positive features – small economy industrial production remains at strong levels, unemployment rates continue to decline, consumer confidence is high, and capital investment is robust.  But overall, the pace of advance has slowed and the data suggest that the growth wave may have crested.

This small economy experience points to a healthy global economy but with increasingly limited upside potential.  The rising GDP growth profile of 2017 should not be extrapolated out: growth expectations need to be revised from great to good.

And although a marked global growth slowdown is unlikely this year, there are some downside risks – particularly relating to policy risk.  As I noted recently, meaningful trade conflict seems low likelihood this year – although the associated elevated levels of economic and market volatility are likely to continue.  But over a horizon of a few years, there is a real risk of serious trade conflict – the systemic drivers of the trade tensions between the US and China are not easily resolved.

Monetary policy normalisation will also create challenges.  Rising interest rates will impact on governments with high levels of public debt, as well as corporate and household borrowers.  And the added complication is that normalisation will not be a synchronised process, because there is increasing regional variation in the global growth and inflation outlook.  In particular, the US has stronger near-term growth prospects – partly because of the fiscal stimulus (poor policy, but short-term positive for growth).  The IMF forecast US GDP growth of 2.9% and 2.7% for 2018 and 2019 compared to 2.4% and 2.0% for the Eurozone.  The Fed will remain well ahead of the ECB in raising rates.

This multi-speed global economy will create cross-winds in 2018: a slowly moderating growth profile in many advanced economies, rising US rates (with implications for the USD), combined with political and geopolitical tensions.  Although GDP growth rates in advanced economies will likely remain reasonable, the global economy will be a more complex and turbulent environment to navigate. It’s no longer a simple Goldilocks global economic recovery.

David Skilling