Global Outlook (October 2016)

Signs of a Shift in Policy Thinking

"The focus is shifting towards greater acceptance of the potential for fiscal policy to support growth if necessary, due to the sense that monetary policy is starting to reach its limits."

– Richard Jerram, Chief Economist, Bank of Singapore; Member of OCBC Wealth Panel

  • Central banks have come round to realise that negative interest rate policies need to be calibrated more carefully, so the harm to the financial sector does not neuter the impact from lower borrowing costs.
  • In any case, there is a limit to how far into negative territory interest rates can go. Even confidence in the soothing effects of ever-more quantitative easing seems to be diminishing.
  • In many cases, fiscal or monetary policy does not offer solutions to the deeper causes of slow growth – issues like demographics or poor productivity.
  • With the U.S. (and even Japan) bordering on full employment, raising potential growth is becoming more important than delivering a short-term stimulus to demand. Unfortunately, in most developed markets there appears to be little commitment to deliver the effective structural reform that is necessary to boost potential growth.
  • The implication is that developed economies will struggle to escape from the sluggish growth of recent years, although downside risks will be limited by a flexible approach to policy marking. That leaves the global economy stuck in the range of 3.0-3.5 per cent growth.
  • The U.S. economy remains in a sweet spot where growth is fast enough to absorb unemployed workers, but not so strong that it is generating much of a rise in inflation. As long as this balance is maintained, the Fed can continue with its cautious approach to tightening monetary policy.
  • A move in early November – just before the presidential election – looks unlikely, so we continue to see the next move as coming in December, followed by another two hikes in 2017. Faster inflation would be a threat to this gradual pace of tightening.
  • Concern that the Eurozone would suffer significant contagion from the UK’s Brexit vote has faded. Taking the purchasing managers’ index (PMI) as the broadest and most timely guide to economic activity, it is hard to see any impact. Readings are still comfortably above 50, at levels associated with GDP growth of around 1.5 per cent.
  • Political risk in Europe is inescapable over the coming year, with the referendum on a new constitution in Italy (probably November), followed by national elections in France, the Netherlands and Germany in 2017.
  • China’s PMI readings show that the manufacturing sector is steady, while non-manufacturing is stronger, which is supportive of claims of re-balancing. Unfortunately the stability comes at a price. The credit bubble continues to expand very rapidly, despite official claims that it will come under control.
  • The partial recovery in commodity prices has eased the pressure on some emerging markets (EM) and allowed a rebound in exchange rates. Several countries are benefitting from improved policy-making, often in the wake of political change.
  • More fundamentally there are signs of improving growth heading towards 2017 in major EM such as Argentina, Brazil, Indonesia, Mexico and Russia. This should help resilience if the U.S. implements two or three rate hikes in 2017, as we expect.
  • Asia still looks solid in the face of sluggish growth in the developed world and troubles in China. Low inflation and (mostly) solid government finances give policy flexibility if needed.