The global economy is projected to register its best performance since 2014 this year. Though geopolitical risks abound, recent economic data point to strengthening growth prospects in most areas of the worl.
This has translated into higher equity valuations in many countries, a reevaluation of the likely interest rate path in the United States and yield curves globally, and significant increases in both household and business confidence. From a purely economic perspective, the risks might actually be characterized as unbalanced toward the positive, for the first time in many years, given the momentum already underpinning global growth. Risks, however, remain very important. The Trump Administration’s approach to trade policy, which has not yet been fully articulated, represents a significant risk to the global recovery. Other geopolitical risks include the electoral cycle in Europe and the potential for sustained capital outflows in China. All this implies that while it may appear that we are entering a stronger, more sustained phase of the global recovery, it is too early to put on our Ray-Ban.
The United States appears to be set for a solid economic performance this year, with growth rising to 2.3% from the 1.6% achieved in 2016 (Table 1). This is well above our estimate of trend growth of roughly 1.7%. Growth in most sectors of the economy appears to be accelerating. Most importantly, there is evidence that business investment is on the rise, as indicators of both business confidence and activity, and orders for capital goods, point to a modest rebound in capital spending in the United States. Continued job gains, the acceleration in wage growth and rising consumer confidence will contribute to another record year for auto sales, and should provide healthy support to the housing market. With growth exceeding trend, and wage inflation accelerating, inflation should be close to the Federal Reserve’s implicit 2% target in 2017. Building price pressure will require significant monetary tightening, and we forecast three 25 basis point increases in the Federal Funds target rate by end 2017. Higher interest rates in the United States, which are not yet fully priced by markets, and improved growth prospects, should lead to a generally stronger US dollar against most major currencies. The rise in the US dollar, and the strength in domestic demand, should lead to a pickup in imports, which should lead to deterioration in the trade balance, potentially inflaming protectionist rhetoric.
Our US forecast reflects only a modest gain from President-elect Trump’s policies at this point, in contrast to the sharply positive view now reflected in asset prices. Our judgment, at this time, is that the President-elect’s fiscal policies will be mildly stimulative over the forecast period. Moreover, any potential increase in growth and prices associated with the policies of the new administration might require tighter monetary policy, thereby limiting their impact. Any measures explicitly designed to discourage imports will be damaging to the United States and its trading partners. This is a key, presently unquantifiable, negative risk to the forecast. Were significant trade actions to take place, the resulting increase in the price of imported and domestically produced goods could lead to even higher interest rates in the United States, even as growth slows.
Canadian growth will accelerate to 2.0% in 2017 from 1.4% in 2016 as the economy benefits from stronger US growth, an increase in oil prices, a weaker currency against the US dollar, and public infrastructure programs. Adding to these factors, and perhaps because of them, businesses appear cautiously confident in their prospects, with firms expanding their hiring while tentatively considering increased investment. We forecast that exports will rise more than twice as fast in 2017 as they did in 2016 as both resource and non-resource exports respond to rising US business activity, the weaker Canadian dollar against the greenback, and higher oil prices.
While our forecast for 2017 is substantially above our trend growth estimate of 1.5%, it incorporates fiscal policies that add about 0.5 percentage points to growth. Absent this boost, growth would be at trend, and just above last year’s level. Two key factors underlie our projection. First, we expect the housing market to cool modestly in 2017 given deteriorating affordability, last year’s Federal measures to cool the housing market, and the rise in mortgage rates observed to date. Housing starts should fall to roughly 190,000 units from the nearly 200,000 units pace set in 2016. As a consequence, residential investment should exert a small drag on growth in 2017, following a modest positive contribution in 2016. Second, auto sales should slow after four consecutive annual records. Given that, there is less replacement demand in Canada than in the United States, which had weak sales for an extended period and only recently returned to a strong sales pace. Owing to the slack remaining in the Canadian economy, inflation should converge to the Bank of Canada’s target on a sustained basis in mid-2018. The resulting interest rate differential with US interest rates should lead to a weakening Canadian dollar through the first half of 2017, followed by a period of gradual appreciation as higher oil prices once again become the dominant driver of the loonie.
Though political uncertainty will remain high in Europe throughout this year’s electoral cycle owing to strengthening support for nationalist/populist movements, data suggest an acceleration in growth in continental European countries. As in the United States and Canada, household and business confidence is rising. Furthermore, retail sales are strong, exports appear to be responding to stronger global demand and the weaker euro, and monetary policy continues to be highly stimulative. We forecast Eurozone growth of 1.7% in 2017, roughly in line with that achieved last year and well above trend growth. Given that core inflation remains low and is expected to remain well beneath the 2% level through 2018, we think the ECB will be in waitand-see mode for the foreseeable future. It will become less dovish only when signs of economic expansion become more entrenched.
In the UK, growth in 2017 will moderate from last year’s torrid pace, but still remain reasonably strong, at 1.6%. The key risk and challenge remains the Brexit negotiations and their impact on economic activity. For the time being, the large depreciation of the pound last year is providing a substantial boost to growth at the expense of rising inflationary expectations. While the feared negative impacts from the ‘Leave’ vote have yet to be seen in the growth numbers, we remain of the view that Brexit will impose some costs as the negotiations get under way and are eventually finalized. This could take a few years. In the meantime, there may be speculation of a more hawkish Bank of England as growth and inflation are expected to remain strong in the first half of the year. This should be unwound if our forecast of no growth in the second half of 2017 materializes.
The outlook for systemically relevant emerging market economies continues to improve, by and large, though capital flow volatility will remain a challenge as markets adapt to the higher US interest rate environment and potential capital repatriation in Mexico and other emerging market countries, and capital outflows in China. Growth in China appears to have rebounded solidly in the second half of 2016, and this momentum is expected to continue into 2017. Yet this positive development does not offset the loss of almost US$1 trillion in international reserves over the past two years. India will remain the fastest growing economy among those we track, though the demonetization program has dampened activity.
In the Pacific Alliance countries, growth in Colombia and Chile is projected to pick up from 2016. Adding to the positive effects of stronger global growth and higher commodity prices (particularly the case in Peru and Chile), increased investment is anticipated following the peace agreement in Colombia, and infrastructure plans and a more pro-growth approach in Peru (this country remains the top-performing economy of the fourmember alliance). In Mexico, a modest slowdown is expected to materialize owing to a combination of factors: fiscal consolidation as the government moves aggressively to improve its fiscal position, higher interest rates stemming from the weaker currency, and a slower pace of investment given uncertainties related to President-elect Trump’s potential policy actions.