EIU global forecast -Central banks braced for slower growth

EIU global forecast -Central banks braced for slower growth

The world's goods-producing industries are under pressure. Amid shrinking global trade volumes, global manufacturing activity stalled in the first half of 2019, and in some developed economies the housing and construction boom that built up over a decade of ultra-loose monetary policy has peaked. Although low unemployment rates continue to fuel the service economy, a growing number of central banks have begun to prepare financial markets for policy easing.

In early June Jerome Powell, the chairman of the Federal Reserve (the Fed, the US central bank), stated that the Fed would respond "as appropriate" to trade developments, causing financial markets to price in a growing likelihood of rate cuts in 2019. Mr Powell did nothing to dispel these expectations in congressional testimony on July10th-11th. Meanwhile, in a speech in June the president of the European Central Bank (ECB), Mario Draghi, stated that additional stimulus would come "in the absence of improvement", a move away from the more reactive approach that the bank had previously adopted.

Central banks are responding to low inflation as well as slowing growth

An important factor behind this shift in stance by the Fed and the ECB is slow inflation. Core inflation measures in both the US and the euro zone have slowed and remain well below central bank targets, and measures of inflation expectations have also softened. With policy interest rates so low, central banks in developed markets can ill afford to let low inflation become entrenched before the next recession hits. In addition, Mr Powell now believes that the link between employment and inflation has weakened, which means that the economy can keep growing for longer before pushing up inflation. Not all Mr Powell's colleagues on the Federal Open Markets Committee are equally dovish, and The Economist Intelligence Unit expects the Fed to sit on its hands in July, before embarking on a policy easing cycle at its September meeting, cutting the federal funds rate by a total of 75basis points by March 2020. The ECB's next move is also likely to be in September, but will be mostly symbolic: a cut of 10basis points to the deposit rate (which currently stands at -0.4%).

US-China trade tensions have stabilised—for now

Our forecast assumes that the trade truce agreed between the presidents of the US and China, Donald Trump and Xi Jinping, at the sidelines of the G20 summit in late June, will continue to hold. Recent developments have been modestly encouraging: at his meeting with MrXi, MrTrump was forced to accept tepid promises from China in return for some significant concessions, including an offer to drop a sales ban against Huawei, a Chinese telecommunications giant.

New trade agreements are taking shape

Existing trade relationships are under threat, but new ties are also being formed. In another major development at the G20 summit, a free-trade agreement (FTA) between the EU and the four countries of the Mercosur customs union (Argentina, Brazil, Paraguay and Uruguay) was announced, almost two decades after negotiations began. This is a milestone event, sending a positive message to investors and creating economic opportunities for both blocs. It brings together a combined population of 780m people in an agreement that will eliminate nearly 100% of EU tariffs and 90% of Mercosur tariffs, assuming that a signed deal is ratified by all Mercosur and EU member parliaments. The ratification process will be politically complicated, and the FTA will probably not come into effect until 2021 at the earliest. However, for Argentina and Brazil, Mercosur's traditionally closed large economies, this will provide time for much-needed economic reforms to boost the competitiveness of the manufacturing and services sectors, which will now take centre stage on the reform agenda.

Trade war escalation remains the biggest global risk

The US's trade and foreign policy will determine the global political and economic outlook in the next few years. All the US's trade negotiations remain open-ended and at risk of collapse. As we had expected, the US-China agreement at the G20 was a trade truce, not a trade deal. We do not expect a written agreement between the two countries, which would result in a reduction of existing tariffs, until 2021, after the US presidential election. Although a deal between the US, Canada and Mexico to replace the North American Free-Trade Agreement (NAFTA) was signed in November last year, it has yet to be ratified, and the legislative timetable makes this unlikely before next year. Meanwhile, Mr Trump is continuing to hold the threat of automotive tariffs against the EU. An escalation of the tariff wars may not be in Mr Trump's political interest during an election campaign, but the risk of a miscalculation is high.

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