As we begin the new year, there are certain key issues that I expect to dominate the macroeconomic conversation and to impact markets around the world. Here, I highlight a few of those issues.
Balance sheet repair and growth
- United States. US gross domestic product (GDP) growth is returning to past norms of 3% to 3.5% thanks to the near-completion of balance sheet repair by the household and financial sectors.
- United Kingdom. The UK is following the US, but with much less balance sheet repair accomplished, and its growth remains vulnerable to the continuing problems of the eurozone.
- Eurozone. The eurozone has only seen balance sheet repair in the periphery — notably Spain and Ireland — but these improvements are outweighed by the lack of deleveraging in France and Italy. I believe eurozone growth will continue to bump along the bottom; no indicators – monetary, fiscal or structural – point to the start of a genuine business cycle upturn.
- Japan. In Japan, Prime Minister Shinzo Abe’s economic policies and the Bank of Japan’s (BoJ) quantitative and qualitative easing have failed to generate balance sheet expansion for the commercial banks. On the fiscal side, the consumption tax increase in April has once again seriously damaged personal consumption expenditure (as it did in 1997). Consequently, consensus estimates place Japan’s 2015 real GDP growth at only 1.3%.
- China. I expect growth in China will continue to slow in 2015 as the economy continues to shift away from investment- and export-led growth.
I expect the US dollar to continue to strengthen in 2015, based partly on:
- Expectations that the Federal Reserve (Fed) will raise short-term interest rates ahead of other central banks in the second half of 2015.
- The relative strength of the US current account. This is the first recovery in more than two decades when current account growth has not deteriorated as a percentage of GDP. This results partly from the fact that industrial production is keeping pace with GDP, suggesting that US manufacturing is maintaining its competitiveness.
I expect the euro and Japanese yen to weaken further, while the pound is likely to weaken against the dollar but strengthen modestly against the euro.
A striking feature of the next year or two will be the marked divergence in central bank monetary stance in the US and the UK on one hand and Japan and the eurozone on the other. While the Fed and the Bank of England are likely to raise rates from the second half of 2015, the European Central Bank and the BoJ will continue with asset purchases and zero interest rates.
However, we should distinguish between rising rates due to normalizing economies versus tighter monetary policy. If commercial banks expand bank credit more rapidly, rising rates may not mean tight money.
Most analysts expect inflation to pick up as growth returns to normal, based on the output gap theory of inflation, which holds that as GDP returns toward trend and the output gap closes, inflationary pressures will resume. However, I believe this view is almost certainly mistaken.
Normally inflation falls in the first two years of a recovery as rising output absorbs excess purchasing power. If we consider that monetary and credit growth remain abnormally low, it is inconceivable that core inflation measures could rise — other than temporarily — in most developed economies in 2015.
In the eurozone, some months of deflation are highly likely because money and credit growth remain too low for long-term price stability. I believe Japan will only just avoid the re-emergence of deflation.
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