Global Outlook (March 2017)

Global Monetary Policy at Turning Point

“Faster global growth and reflation implies that the next move in monetary policy in the Eurozone and Japan is likely to be towards tightening, even as the Fed prepares to hike rates further”

– Richard Jerram, Chief Economist, Bank of Singapore

  • Global economic growth continues to improve and, together with firmer commodity prices, this is reducing the risk of deflation. Headline inflation rates have picked up across the developed world, although core inflation has been slower to respond as it typically excludes the effect of higher oil prices.
  • Faster growth and higher inflation spells a turning point in global monetary policy. Of course the U.S. is already tightening and various emerging markets seem to have stopped cutting rates, so the focus is on other developed markets. In 2H2017, we can expect to see the Eurozone planning to taper asset purchases and Japan start to increase the target yield for bonds.
  • In the U.S., the “America First” attitude will be a persistent risk. With the trade deficit already at 4 per cent of GDP, and set to expand due to the strong U.S. dollar and tight domestic capacity, tariff protection will be a constant threat.
  • In Europe, the dichotomy continues between an increasingly solid economic performance and continued political turmoil and uncertainty. PMI readings show Eurozone business confidence at the highest level since 2011, while unemployment has been falling steadily for over three years.
  • The improving economy seems to have done little to reduce public dissatisfaction with the political status quo. This should not be too much of a surprise, as the U.K. and U.S. both enjoyed a stronger recovery than the Eurozone from the recession of 2008-09, but were not immune to unexpected election outcomes last year.
  • The U.K. is treading a perilous path towards Brexit and there is the 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, the pick-up in regional trade has boosted Japan’s exports in recent months, even before we see the likely benefits of the recent currency weakness. In turn this is driving a rebound in industrial output that will feed through to corporate profits.
  • As in Europe, solid economic growth means that discussion is turning to the question of when the Bank of Japan (BOJ) might start to tighten monetary policy. Assuming that inflation picks up a little in coming months and the exchange rate remains soft, the BOJ could look at raising the target for 10-year bond yields around the middle of the year. This could bring the benefit of reducing a source of potential friction with the U.S., as well as reducing the pressure for the BOJ to expand its balance sheet so rapidly.
  • In China, concern over the overheating housing market has brought some macro-prudential policy tightening, as well as a slight squeeze on liquidity. This points to slower growth in coming months, but it seems unlikely to risk a serious undershoot of targets.
  • Policy-makers’ priorities have been clear in recent years, with the determination to deliver solid growth taking precedence over efforts to control the credit bubble. As a consequence, the debt service burden is rising, bringing the risk of a rise in non-performing loans. However, most of the debts are in local currency, so the government should be able to prevent abrupt systemic disruption.
  • The recovery in emerging markets is threatened by higher U.S. interest rates and trade protectionism. Asia is relatively less exposed to a rise in borrowing costs, as most economies run a current account surplus, so are exporters of capital.
  • Conversely, Asia is badly exposed to a reversal of the globalisation of the past few decades. Even if America’s protectionist focus is on China, the rest of the region is indirectly threatened, as much of the trade with China is ultimately dependent on demand from the United States.