China’s investment in infrastructure is helping to support global growth

US interest rates have been raised twice in three months for the first time in more than a decade. Global growth is picking up and inflation has been rising. Little wonder that talk is rife of a return to ‘normality’. A halt to eurozone quantitative easing next year now seems plausible.

The global cyclical upturn is the most synchronised in years. Even Brazil and Russia are finally turning the corner and there are big improvements in European industry. But, while much of the market optimism relates to the US, China’s demand is supporting more of the world’s exports. These countries are again the world’s growth engines while economies running current-account surpluses hitch a ride on their coat-tails. 

So while near-term growth prospects continue to strengthen, the longer-term implications of this growth mix – ongoing imbalances, financial-stability risks and, if trade tensions intensify, renewed concerns about global growth – are likely to be less benign.

Consumer spending has been the world’s major driver, boosted – particularly in the West – by higher employment and lower oil prices

For now, though, better-than-expected global data means that we’ve edged up our forecasts. We expect worldwide GDP growth to pick up to 2.6 per cent this year and 2.7 per cent in 2018, with the developed world on 1.9 per cent in both years but emerging economies growing 4.2 per cent in 2017 and 4.6 per cent next year.

Our US forecast is 2.3 per cent followed by 2.7 per cent but, despite big upgrades, our expectation for the eurozone is 1.5 per cent, slowing to 1.4 per cent.

Yet key factors supporting the industrial upturn could be temporary – such as stock-building and fiscal stimulus, especially in China. For the improvement in the world trade cycle to be sustained it is the broader demand drivers that will matter, and in particular whether we see a recovery in capital spending.

Consumer spending has been the world’s major driver, boosted – particularly in the West – by higher employment and lower oil prices. But the oil windfall is fading, and ageing populations spend more on services than on traded goods.

Government spending is now also supporting global growth, particularly China’s infrastructure investment, while tax cuts and some public spending should boost US demand in late 2017 and 2018. The hope is that US deregulation and Chinese reforms will feed into stronger private-sector demand growth and higher productivity.

Commodity producers such as Australia and Brazil are clearly benefiting from China’s higher demand for imports, as are Asia’s electronics producers. Japanese and eurozone exports have picked up on the back of Chinese demand, too.

So despite this increasingly optimistic near-term growth outlook, the US current-account deficit will likely widen while other countries’ already-large surpluses continue. As long as US growth holds up and the Federal Reserve gradually tightens, excess savings from the world’s surplus economies should still flow into the US, potentially posing financial stability risks.

Trade protectionism is not the answer, though. It would raise US consumer prices and create few jobs. And until domestic savings patterns change in Germany and Japan, those countries remain vulnerable to any growth disappointment and are a medium-term deflationary influence on the global economy.

A synchronised global recovery might be expected to simplify the Fed’s job of setting monetary policy. But global imbalances, financial stability risks, protectionist threats and big uncertainties over the timing and scale of the forthcoming fiscal package all pose challenges.

We expect two more US rate rises in 2017 after March’s increase, but we doubt the Fed can keep tightening three times a year until it reaches its estimated long-term neutral rate of 3 per cent. We expect only one rate rise in 2018.

This research was first published on 23 March 2017.
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