Viewpoint The time has come to verify the accurateness of the forecasts we laid out a year ago: the evolution of the economic cycle and of inflation in 2019 were roughly in line with our expectations…….
Intesa Sanpaolo – Research Department
Also very close to the mark were our forecasts in terms of Brexit and the trade wars engaged by the US, as well as our exchange rate projections.
However, the downswing of activity in the manufacturing sector was longer than expected and extended uncertainty resulted in lower average annual growth.
Therefore, we underestimated the inclination of the Federal Reserve and of the ECB to further loosen monetary policy.
– A year ago, our forecast scenario for 2019 correctly took into account a negative fallout on economic activity tied to US trade policies and to the unfavourable industry-specific developments that had started to emerge over previous months.
Our growth forecasts pointed to a slowdown compared to 2018, from 2.9 to 2.5% in the United States, from 1.9% to 1.5% in the Eurozone and from 6.6 to 6.3% in China.
In addition, a further slowdown was expected to take place between 2019 and 2020. Our projections were marginally lower than consensus estimates as at December 2018, and as a result emerged as being more accurate on average.
The underlying assumptions included a further escalation of the tariff war between China and the United States, albeit not the materialisation of a worst-case scenario; in the end, this was broadly correct.
We were also right not to expect a no-deal Brexit. The forecasting error on GDP growth, therefore, amounted to 0.2 points for the United States, 0.3 for the Eurozone and 0.1 for Japan and China. Overall, the resulting scenario did not differ much from expectations.
– On the other hand, our estimates were a little more distant from the final outcome on the evolution of consumer prices.
While we did expect a cooling of the price dynamics, the slowdown was sharper than forecast in the Eurozone, to 1.2% and not to 1.7%, and smaller in the United States (to 1.8% rather than to 1.4%). This was due in part to the rather weak trend of oil prices.
– The resulting implication is that our forecasts on monetary policies proved to be too conservative. This was our most evident forecasting error.
The Federal Reserve fully caved in to market expectations, setting out on a monetary policy easing cycle that was strikingly at odds with the indications provided earlier by the FOMC itself.
Also, the ECB did not simply announce a new round of TLTROs, as we had expected, but announced in September a substantial package of measures, which also included a slight reduction of policy rates and the resumption of net purchases under the APP.
In fact, the relatively modest forecasting error on growth was connected a very extended period of uncertainty, during which the threat lingered of an involution of the economic situation, which scared central bankers.
In hindsight, therefore we had greatly overestimated the central banks’ tolerance to risks to the growth scenario.
– All the above did not prevent us from correctly forecasting the trend of many exchange rates, the sensitivity of which to monetary policy decisions decreased.
The euro is closing the year at just above 1.10, as expected, and sterling made up ground against both the euro and the dollar. The largest discrepancies concern safe haven currencies, which are stronger today than we had expected a year ago.
As for the future, there are convincing signs that economic activity may reaccelerate in the first half of 2020.
However, visibility on the longer horizon is very limited and expectations for a further strengthening of the economy clash with the opposite trend we expect to prevail in the United States and in China.
At what point will the global slowdown which began in 2018 end? What is the risk of the contraction of manufacturing output in the advanced countries evolving into a global recession?
The answers to these questions depend on an articulated set of factors: the inertia of current trends, the economic policy measures implemented by governments and the potential emergence of new, unexpected shocks (whether positive or negative).
First of all, let’s examine the current trends. Monthly surveys, including PMIs, have already outlined a significant rebound of the aggregate manufacturing index, back at levels consistent with positive monthly changes.
The improvement, initially limited to the emerging countries, extended in November to advanced countries as well.
Furthermore, the decline of the services index ended, enabling the composite PMI to rise back marginally from its trough.
A signal that the downtrend may have bottomed out also came from the forward-looking index referred to China, probably in response to the economic policy stimulus measures put in place to counter the slowdown, a signal which typically preludes to a global recovery.
The PMI sub-index which measures foreign orders is still on a downtrend and signals that the short-term trend of global trade is still weak, despite the stabilisation of the rate of contraction.
World trade will probably only resume growing in the spring of 2020, when the calculation of the changes will no longer include the months in which flows adjusted to US trade tariff hikes.
However, the outlook has improved thanks to the forthcoming ratification of USCMA, the provisional agreement reached by China and the United States and, lastly, by the prospect of an orderly exit of the United Kingdom from the EU.
The evolution of fiscal and monetary policies turned to the support of aggregate demand, albeit not decisively so.
While the IMF’s Fiscal Monitor did not outline a significant decline of the cycleadjusted primary balance in 2020, the budgets drawn up by the European governments imply a greater loosening than estimated by the IMF and are consistent with a marginal easing in the advanced countries, from the -0.4% rate already observed in 2018 and in 2019.
Furthermore, massive easing in the emerging countries in 2019 (-0.8% of potential GDP, according to the IMF) will support demand in 2020.
Monetary policies remain generally accommodative: the Bank of Japan and the ECB are implementing explicit quantitative easing programmes, that are squeezing interest rates and risk premiums.
In both cases, stimulus will continue throughout 2020; at the same time, the margin available to the two central banks to react to a deterioration of the situation seems very limited.
The Federal Reserve is also injecting new reserves, although for more technical reasons, and only recently put on hold its downward action on policy rates. In this case, a poorer than expected evolution of the economy would probably prompt a new loosening of monetary policy.
Overall, therefore, forward-looking indicators, monthly survey data and information on the trend of fiscal and monetary policies all support the prospect of a moderate but geographically widespread reacceleration of growth in the course of 2020, albeit not to the point of guaranteeing stronger average annual growth than in 2019.
As the trend of GDP in the central months of 2019 did not significantly stray from expectations, GDP growth forecasts for 2020 have not been significantly revised in any of the major advanced countries, nor in China.
However, important cuts forecast average annual growth were implemented in India (affected by a particularly weak third quarter of the year) and Latin America.
For what concerns average consensus forecasts, there were virtually no changes compared to three months ago for the United States, Japan, the Eurozone, Canada and the United Kingdom; in this case as well, forecasts for Latin America, on the other hand, were revised down sharply, from 2.0% to 1.5%. At present, our growth forecasts do not differ significantly from the average consensus levels.
For what concerns the sustainability of this phase, it is hard to make forecasts. The extension of the expansionary phase, all other conditions being equal, increases the probability of a recession.
Several advanced economies are already operating with very low unemployment levels, and we think average annual growth will keep slowing in the United States and China in 2020-21. In the euro area’s case, we currently expect economic growth to accelerate in 2021, in line with the forecasts drawn up by the ECB, the European Commission and the IMF.
However, there is close to no visibility on 2021 and a number of risk factors could materialise and result in dramatically different outcomes. Specifically, in addition to the usual imponderables tied to geopolitical risk:
- The trade wars engaged by the United States seem to have been put on hold for the time being. The scenario which underlies our forecasts rules out a resumption of tariff hikes against China following the signing of the so-called “Phase1” agreement, and expects a deal to be signed with the EU preventing the introduction of higher trade barriers. However, there are no certainties on this front.
- If the United Kingdom effectively leaves the EU on 31 January, the two sides will have until 31 December to negotiate an agreement governing future permanent relations: probably not enough time, considering the complexity of the process. Therefore, the risk lingers of trade barriers between the EU and the United Kingdom growing in 2021 in much the same way as they would have in the event of a hard Brexit. Our base-case scenario does not consider this outcome, prevented either by a ratification of the agreement in time (which seems unlikely), or by an extension of the transition period to allow negotiations on future relations to be completed.
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