• The IMF recently downgraded global economic growth forecasts;
• Europe and China are the major worries;
• There has also been downgraded forecasts for the Australian economy;
• More than just lower interest rates is likely to be necessary to get the economy moving.
‘And maybe tomorrow is a better day
I know tomorrow is a better day’
Poets of the Fall
A common theme over time in songs, poetry or literature is the hope that tomorrow will be a better day. Few would put economists in the artistic boat. But the consistent theme of most economic forecasts post the GFC has been that tomorrow will be better. And to some extent that has been true. The global economy did have a good run 2016-17. The labour market has been strong in many countries. But by and large since the GFC for many people tomorrow has not often felt like an economic better day.
Recent forecasting disappointments has not stopped economists projecting brighter times. The latest example comes from the recently released IMF world economic forecasts. The IMF note that the economic growth outcome for this year is now likely to be well below what was thought possible this time last year. Stronger growth is forecast for the next couple of years, albeit less robust than previous projections. The forecast pickup in growth is currently just that: a forecast.
The growth downgrade has been across most regions, although the IMF still has some optimism about the US. The US economy has performed best over recent years. But it has not been immune to the global downturn in manufacturing. The service sector has done better but is showing signs of losing momentum. The US unemployment rate is near multi-decade lows.
A model using the slope of the yield curve (difference between 10-year and 3-month US Government interest rates) suggests that the probability of a recession in the US at some stage over the next year is rising. Economists are even more concerned. At least the US has a few policy bullets still to fire. The Federal Reserve has cut rates twice this year. Markets think that at least two more will be needed over the next 6-9 months. The looming 2020 Presidential election will almost certainly mean that the fiscal pump will be again primed.
There are bigger economic concerns about Europe. Spain and Greece are doing better. France has had a decent 2019. But Italy is essentially in recession. And weak global trade and problems in the car industry has likely pushed Germany into one. The ECB has put its hefty shoulder to the economic wheel. But with interest rates already negative it is no longer able to move the economy as far and fast as it would like. Some countries (notably Germany) can do more fiscally. High levels of government debt constrain others (such as Italy).
Most important has been the weakening of the Chinese economy. Partly that reflects structural factors (aging population, it gets hard for big economies to keep growing quick). Partly it is a policy of choice as the Chinese Government looks to ensure that economic growth is sustainable (ie, move from investment-led to consumer-driven economy, reduce debt, cut pollution, reverse income inequality).
There is no question that the Chinese Government is both smart and focussed on achieving its economic goals. It also has more economic tools at its disposal than most governments. But even in the best of times it is an ambitious agenda they are trying to implement. The weakening global economy and rock-bottom interest rates makes things that much harder.
IMF World Economic Growth Forecasts
(annual % change)
Probability Of US Recession
GDP Forecast For Euro Zone One Year Ahead
(annual % change)
China GDP Forecasts For 2020
(annual % change)
Australia maybe a physical island but it is certainly not an economic one. In line with the global trend, forecasts for the Australian economy have been downgraded over the past year. The latest Reuters survey indicates that expectations for 2020 have moved from an above trend 2.75% last year to a sub-par 2.4%. And the skew to economist forecasts is towards weaker growth.
The reasons are well known. Economic momentum in the first half of this year was weaker than expected. The RBA and the economist community more generally expect a better second half. Tax cuts will help, a turn in the house price cycle and (some) pickup in mining capex will do their bit.
But the global economy is not good. The downturn in the residential construction cycle still has some way to run. A sustained pickup of wages growth is somewhere in the distance. Strong jobs growth has been a feature of the economy over the past couple of years. But the signs are that there will be some weakening of the labour market. An index of leading economic indicators points to slowing growth.
Median GDP Forecasts For 2020
(annual % change)
Range Of Economic Growth Forecasts For 2020
(nos of participants per GDP forecast)
Australia Leading Economic Indicators
(annual % change, 3 month average)
Job Ads As Proportion Of Labour Force
Slowing economic growth and weaker outcomes has led analysts to also revise down their inflation forecasts. The CPI is expected to only just be at the bottom end of the RBA’s target band next year. Financial markets are more pessimistic. Price expectations for both firms and consumers are also low.
Median CPI Forecast For 2020
(annual % change)
Australian Financial Market Inflation Expectations
(5 year, 5 year forward)
Business Price Expectations
(SD from average)
Consumer Inflation Expectations
(3 month average, eighted mean)
The weaker than expected growth has led to the RBA cutting rates three times so far in 2019. With expectations of sub-par economic growth and low inflation investors expect another rate cut by the RBA will be necessary. The RBA has indicated that ‘unconventional policy’ might be implemented as the cash rate moves below 0.5%. Arguably that has already started. The RBA has provided a form of ‘forward guidance’ (where they indicate where they expect the cash rate to be in the future) stating that ‘an extended period of low rates will be required’. Financial markets agree, pricing one more rate cut and then at least 4-5 years of an unchanged cash rate.
But there is an increasing debate about whether rates at current low levels work. Central banks say yes but admit there is less bang for each (rate cut) buck as rates go lower. The level of rates is not holding back the economy but the lack of demand and income growth. Governments are spending more on infrastructure and NDIS, as well as cutting taxes. More government involvement is likely to be necessary. Improved productivity growth would also help.
So there is hope that there will be better times ahead. Central banks have done their bit. But the better days are likely to require more than just lower interest rates.
We live in interesting times!
Peter Munckton - Chief Economist