Annual Economic Outlook 2017 by Invesco

Under Donald Trump’s leadership, US GDP is widely expected to accelerate, but I expect only a modest upswing to 2.4% in 2017 and 2.6% in 2018, not a growth rate of 3.5-4.0% as promised in his election campaign.

Moreover, most of the incremental growth in 2017 will come not from fiscal stimulus, tax cuts or infrastructure spending, but from the strengthening business cycle upswing which Mr Trump has had the good fortune to inherit.

US consumer price index (CPI) inflation may rise moderately, but will not be much affected by the fiscal deficit. Unless money and credit growth accelerate, inflation will remain broadly unchanged, around 2%. In October core personal consumption expenditure (PCE) was 1.7%; core CPI was 2.2% year-on-year.

Following the 0.25% hike in the US federal funds range in December, I expect the US Federal Reserve (Fed) will raise interest rates two or three times in the year ahead, taking the target range to 1.00-1.25% by yearend 2017.

In the Euro-area the outlook remains subdued in the short term, and still far from robust in the long term. Recently extended to December 2017, at a reduced rate of €60 billion per month from April 2017, the European Central Bank’s (ECB) flawed quantitative easing (QE) strategy continues to fail to gain traction.

As a consequence the arguments for fiscal easing in Europe are becoming fashionable, but European Commission (EC) rules do not offer much scope for change, least of all fiscal expansion backed by monetary acceleration.

Meantime, the Italian referendum result shows that political pressures for fundamental changes to the European Union (EU) are gaining ground.

Eurozone real GDP will slow to around 1.2% in 2017, while inflation will continue to fall well short of the target of “close to but below 2%”.

The continued Brexit fallout will slow Britain’s real GDP growth, particularly foreign direct investment (FDI) in the UK. Meantime, the Bank of England’s (BoE) credit promotion policies implemented in August risk adding domestically generated inflation to imported inflation from weak sterling.

I expect UK real GDP growth to be 1.5% and consumer price inflation to rise gradually towards 3% during 2017.

In Japan the three-pronged programme of Prime Minister (PM) Abe has failed to re-ignite growth, while the Bank of Japan’s (BoJ) quantitative and qualitative easing (QQE) programme has failed to raise the underlying growth rate of broad money (M2).

Consequently I expect Japan’s economic growth rate will remain around 1%, and the economy will continue to hover on the edge of deflation.

Among the emerging economies there is also a divergence between commodity producers and manufacturers, with the former suffering from weak terms of trade, but the latter still awaiting a fully-fledged upturn in the developed economies that are the major buyers of their products.

A number of emerging market (EM) economies have increased their debt levels substantially over the past eight years, requiring domestic or external debt workouts, delaying the process of recovery.

China is a particular enigma. On the one hand the authorities have permitted a very rapid growth of credit directed to the government and financial sectors, but on the other hand, overcapacity in basic industries such as coal and steel, and rising non-performing loans in the state-owned sectors are constraining the growth of new investment.

The result for China has been a series of mini-bubbles in equities (in 2014-15), in the bond market, in parts of the Chinese real estate market, and most recently in various commodity markets (e.g. soy beans, coking coal, iron ore and steel).

On the external side China is grappling with growing capital outflows that now outweigh the current account surplus. The overall payments deficit has forced the Chinese authorities to allow a degree of yuan depreciation, combined with intervention in the foreign exchange market (resulting in a decline in foreign exchange reserves) and the enforcement of tighter controls on capital outflows.

In spite of these short to medium term setbacks in the recovery process my longstanding view has been that the current global business cycle expansion will be an extended one. The main reason is that sub-par growth and low inflation would avoid the need for the kind of tightening policies that would bring an early end to the expansion.

It is also the case that recessions or growth weakness in the EM economies are unlikely to derail the modest-paced recovery in the developed economies. While some companies or sectors cannot avoid being affected by the problems of the EM, the transmission of key fundamental forces – like monetary policy and balance sheet repair – still goes primarily from developed markets to EM, not vice versa.

In addition, the recovery in the US, although already seven and a half years old, is only now starting to take on the typical characteristics of a normal recovery: banks have been providing credit instead of the Fed, businesses and households are in good financial shape and can resume normal spending momentum.

John Greenwood – Chief Economist – Invesco Ltd.