Global Economic Update

This is the global economy update for the year 2014 and a prediction for 2015.

China: after the Chinese economy grew at its slowest pace in five years (7.3% (year-on-year growth) – according to official data) in the September (third) quarter, GDP growth could possibly be lower in the December (fourth) quarter as the growth momentum may continue to falter or lose traction due a host of factors; cooling down of China’s property sector which continues to dampen domestic demand and broader economic activity – reflected in low capacity utilization and decelerating inflationary trends; stalling of factory growth – the HSBC/Markit Manufacturing PMI fell to a six month low to 50 in November from 50.4 in October, which has raised market concerns that China’s manufacturing sector is not only slowing down but getting close to contraction; unexpected drop in industrial output growth in October; uncertainty about export prospects; industrial overcapacity; and, slowing down of credit and business investment growth (slowing down of credit growth is adversely affecting investment growth).

Having stated the above, the Chinese economy seems unlikely to achieve the 7.5% official growth target for 2014 and is likely to grow annually at a slightly lower rate than the aforesaid official growth rate target. Further, the protracted correction of China’s property market is likely to act as a drag on growth in 2015.

The central bank in China (PBOC) reduced its benchmark interest rates unexpectedly on Friday (November 21st) for the first time in more than two years. It reduced its benchmark lending rate by 0.4% to 5.6% and reduced its benchmark rate for one year deposits by 0.25% (i.e. from 3% to 2.75%) – stepping up efforts to shore up the flagging economy. It might be noted that as growth in China slowed this year, there have been a series of fiscal policy and monetary policy measures ( i.e. stimulus measures) to spur growth.

I’m not so sure that the latest monetary easing (reducing benchmark interest rates) is potent enough to counter the deceleration in growth, primarily due to the distressing slowdown in fixed asset investment growth – a key driver of the Chinese economy; slumping property market which continues to act as a major drag on the broader economy; and, slowdown in credit growth. I should expect more aggressive interest rate cuts in 2015 by China’s central bank to shore up the economy.

Japan: domestic spending continues to languish and the Japanese economy is faltering. This economy unexpectedly fell into recession in the third quarter of 2014.

The Japanese economy contracted for the second consecutive quarter (technically known as a ‘recession’) in the third quarter of 2014, with GDP falling by an annualized rate of 1.6% in this quarter after declining by 7.3% in the second quarter – reflecting widespread weakness in demand.

The April sales tax hike from 5% to 8% is largely responsible for having adversely affected economic activity more than expected, as it weighed heavily on consumer spending and business investment. Fortunately, one need not be too gloomy about the Japanese economy – Japanese exports rose at their fastest rate in eight months in October 2014, which might help it to recover from the recession. Further, though Japan’s Markit/JMMA Manufacturing PMI decreased marginally from 52.4 in October to 52.1 in November (reflecting an easing in manufacturing activity), yet manufacturing output grew at its fastest pace in November since March according to this survey – which is suggestive of a tentative economic recovery. Moreover, the yen has fallen substantially against the dollar, which could boost exports (and possibly help the economy to regain momentum) and counter deflationary pressures in the coming months.

Last month the Bank of Japan shocked markets by resorting to more quantitative easing ( a form of unconventional monetary easing) – which should possibly add modestly to growth and help counter slowing inflation.

Having stated the above, it is now an imperative that the government pursues the third arrow of ‘Abenomics’ known as structural reforms (which can be challenging) to strengthen the supply side of the economy, in order for the Japanese economy to recover and grow in a sustainable manner. The other two arrows of ‘Abenomics’ – monetary easing and fiscal spending – were initiated in Japan last year to counter deflation and reverse the economic stagnation of over two decades and revive the economy. These arrows seemed to be meeting with some success, however, the April sales tax hike and its adverse effect on the Japanese economy coupled with other reasons have once again demonstrated that the third arrow of ‘Abenomics’ needs to be implemented or undertaken with compelling urgency – to firmly put this economy back on track and pave the way for sustained economic growth.

United States: the US economy grew better than expected in the third quarter of 2014 – the second consecutive quarter in which the economy grew strongly after a disappointing first quarter. The US economy grew by an annualized rate of 3.5% in the third quarter after growing by 4.6% in the second quarter. Essentially, the US economy seems to be recovering well as growth is gaining momentum.The labour market is gradually improving which augurs well for consumer spending – the cornerstone of the US economy (i.e. it accounts for around 70% of the US economy) – which in turn should further support growth in the coming quarters.

According to official data, the unemployment rate fell to a six year low of 5.8% in October from 5.9% in September and employers added 214,000 jobs in October –a reflection of solid job growth in this month. However, the pace of wage growth remains sluggish and is barely above the rate of inflation, which in turn is preventing consumer spending from growing more rapidly. Wage growth is a key indicator to watch out for,as consumer spending is the main driver of the US economy and consequently pivotal for the sustainability of growth in the coming quarters.

With the tightening of the US labour market, one should expected wage growth to rise in the coming months – which coupled with rising consumer confidence and lower mortgage rates should lead to higher consumer spending and support housing market activity in the coming quarters.

It might be noted that consumer spending growth continued to remains modest in the third quarter, while business investment activity grew steadily in the same quarter (and is likely to grow at a stronger pace in the coming quarters). Exports also held up in this quarter, despite slowing global economic growth.

Having stated the above, there are two important factors that could possibly act as a drag on the US economy in the near future; a possible global economic slowdown and a stronger dollar against major currencies such as the euro, yen etc. (which could adversely affect US exports and consequently growth). Having said this, I believe that overall the US economy  is likely to continue to grow at a decent pace in this coming quarters along with further improvement in the labour market.

Finally, I do not really envisage the Federal Reserve raising interest rates until after mid-2015, possibly due to the increasingly worrying global economic outlook and stronger dollar against major currencies such as the euro, yen etc (which could hurt US growth) and very low levels of inflation (and inflation expectations). Further, the Federal Reserve may want to wait until wages grow at a faster pace in the coming months and demonstrate a significant upside.

Eurozone: economic recovery remains tentative in the eurozone. According to official data, GDP grew by 0.2% in the third quarter of 2014 from 0.1% in the second quarter – a reflection of very weak demand conditions in the eurozone (which is dampening output growth and job creation in this economy).

Actually, the eurozone was able to register such a quarterly growth rate in the third quarter as a result of the German economy growing marginally in the same quarter (after having contracted in the previous quarter) and the French economy growing at a more rapid pace than expected (also in the same quarter).Germany and France are Europe’s largest economy and the second largest economy respectively. It might be noted that the eurozone’s third largest economy – Italy – is in recession.Clearly these three largest economies of the eurozone are languishing.

The manufacturing sector activity in the eurozone continues to remain very weak. Markit Purchasing Managers’ Index (PMI) for manufacturing fell to 50.4 in November from 50.6 in October – which has added gloom over the outlook of the eurozone economy. It might be noted that the manufacturing PMI is an important indicator of business conditions in the eurozone and also provides valuable advance signals about the economic prospects of this economy.

What is particularly distressing is that the continued economic stagnation in eurozone coupled with the possibility of this economy entering into a recession could have adverse implications for US and UK economic recovery and consequently global economic recovery. Demand conditions in the eurozone remain very weak as reflected by the distressingly low inflation that continues to beleaguer the economy. According to official data, inflation in the eurozone was 0.4% in October 2014 – much below ECB’s (European Central Bank’s) inflation target of close to, but below 2%. Clearly the threat of deflation looms large over this economy. Further, large parts of the eurozone continue to struggle with high unemployment and sluggish job growth.

Having stated the above, eurozone’s anemic growth amply demonstrates the need for more aggressive monetary easing coupled with expansionary fiscal policy and structural reforms (long over due), in order to put the eurozone economy on the path of sustained economic recovery and growth. More specifically, in addition to monetary easing, countries in the eurozone need to enact structural reforms, pursue sound fiscal policies, cut red tape, reduce tax burden on labour and make this economy significantly more business friendly – in order to boost domestic demand, kick start investment activity, enhance international competitiveness, reduce unemployment and bolster growth on a sustainable basis. Further, banks also need to start lending more to support investment and growth in this economy.

United Kingdom: The UK economy grew at a sound pace in the third quarter of 2014 by 0.7% (quarter-on-quarter) despite the slowdown in eurozone, after having grown by 0.9% in the second quarter (according to official data).Though growth in the third quarter is slightly down from the previous quarter, yet it must be noted that the UK economy has been expanding impressively this year after growth started to pick up in 2013. On the whole, the UK economy seems to be in reasonably good health and growing relatively smoothly.

The key point to note is that the slowdown in services sector (which represents 75% of output) held back growth in the third quarter, though it was the key driver of growth. Further, all main sectors of the economy grew in this quarter and growth was broad based. However, what must be noted is that the manufacturing sector expanded at a slower pace compared to the previous quarter and going forward continued weakness in the eurozone, recession in Japan and a slowing global economy may lead a further easing of growth in this sector. GDP growth is likely to moderate slightly in the fourth quarter, due to growth easing in the services and manufacturing sector.

Having stated the above, a point worth mentioning is that business investment in the UK continues to grow strongly (which is pivotal for sustainable growth) and I would expect this trend to continue in 2015 ( though business investment growth may be slower in 2015 than in 2014).

Next, I would really envisage an interest rate cut by the Bank of England possibly after mid-2015, due to the worrying economic prospects of the eurozone (which is flirting with recession) which is likely to adversely affect the UK economy in the coming months (as the eurozone is UK’s largest export market), subdued or weak earnings growth of people employed and inflation remaining worrying low (below the Bank of England’s inflation target). According to official data, inflation on the CPI measure edged up slightly to 1.3% in October from 1.2% in September in UK. However, due to falling international oil prices and other reasons, inflation might dip again in the coming months.