Global Outlook (February 2017)

Faster Growth but Rising Risks

“Economic growth has picked up, but the early days of the Trump presidency have highlighted the risks to a liberal world order led by the United States.”

– Richard Jerram, Chief Economist, Bank of Singapore

  • The rebound in business confidence began ahead of the U.S. election and has been a global occurrence, so it does not appear to be driven by Trump’s victory. However, in the U.S., hopes of fewer regulations and lower taxes might be behind a post-election spike in confidence, especially for small firms.
  • Deregulation, tax reform and infrastructure investment in the U.S. all have the potential to raise the U.S. growth rate, but passing the legislation will take time, and the economic impact will be gradual. A more immediate concern is that cutting taxes when the economy is already running hot is likely to boost inflation and widen the trade deficit.
  • Protectionism is our greatest concern. Tariffs would threaten to reverse the globalisation that has been at the heart of the success story of many emerging markets – especially Asia – in recent decades. The U.S. would also suffer from distortions to resource allocation and higher prices to consumers, even before we consider the risk of retaliation by major trading partners.
  • In Europe, elections in Netherlands, France and Germany, imply continued uncertainty in 2017, especially in the wake of the political surprises of 2016. Unavoidably the focus is on downside risks, including the survival of the Euro. However, there is also the possibility of positive outcomes, such as the election of a reformist right-of-centre president in France.
  • The U.K. is treading a perilous path towards Brexit and there is a danger that it leaves the European Union without securing any form of preferential access for trade relations. Large budget and external deficits limit the room for manoeuvre and leave the U.K. exposed to damage from Brexit.
  • In Japan, exports and output were already benefitting from the bounce in world trade seen in late 2016, and the drop in Yen should sustain that momentum. This will compound the tightness in labour markets, which are already the best in 25 years.
  • Unfortunately (from the Bank of Japan’s point of view) deflationary expectations appear to be so entrenched that wages have shown very little response to labour shortages. Similarly, prices are stable and although inflation will be boosted by the weak exchange rate, the BOJ’s 2 per cent target is still far in the distance.
  • China could be the target for U.S. protectionist policies. Trump’s appointment of related officials supports this view. Japan and Mexico have also found themselves under scrutiny, but the deficit with China is five times as large as either of them.
  • Any Chinese response to U.S. tariffs is likely to target specific U.S. firms. The hope is that this leads to more moderate behaviour from the U.S. side, but the risk is that it is viewed as provocation that leads to an escalating trade war. The unpredictability and inexperience of the U.S. administration makes this a realistic concern.
  • All emerging markets – not just China – are at risk from U.S. protectionism. Even if China is the primary focus, many of Asia’s regional production networks depend on assembly in China for eventual export to the United States. Moreover, if the (probably unachievable) objective is to create millions of new manufacturing jobs in the U.S., penalising China only to see the trade deficit shift to other countries is likely to provoke similar measures on other exporters.