Drifting world economy skirts the worst but still lags

By Jeff Black, Enda Curran, Rich Miller

How is the world staying afloat? Photo / Getty Images
How is the world staying afloat? Photo / Getty Images

Call it the drift economy: The world somehow manages to stay afloat yet doesn't go much of anywhere very fast.

Supported by a surfeit of central bank liquidity, the world has skirted numerous hazards and grown at a steady, albeit unspectacular, pace since 2010. And it looks set to do it again in the coming year, slowed, though not swamped, by the UK vote to leave the European Union.

"We might end up losing perhaps a quarter percentage point off" world growth as a result of Brexit, said David Hensley, director of global economics for JPMorgan Chase & Co in New York. "That's not enough to knock us out of the 2 to 3 percent channel we've been operating in recent years."

Coming after the deepest recession since the Great Depression, the slow-motion expansion has failed to extinguish the lingering anxiety of consumers and companies scarred by the crisis. That's led both groups to hold back on their spending, in turn retarding the strength of the upswing.

"It's been a disappointing expansion, just drifting along," said Peter Hooper, chief economist for Deutsche Bank Securities Inc. in New York and a former Federal Reserve official. It has, though, been sufficient to reduce joblessness, especially in the US, he noted.

The question is how long the lackluster status quo can last. Central banks have already pushed monetary policy to its limits, cutting interest rates below zero in some countries and buying up bucket-loads of government bonds.

Populist pressures fed by stagnating living standards are mounting, leading to the June 23 British vote to leave the EU and the rise of the unlikely duo of Donald Trump and Bernie Sanders as candidates for president in the US.

And financial markets appear flummoxed, with falling bond yields signaling escalating angst among investors about the outlook while buoyant stock prices suggest an absence of much concern.

For now, though, the drift seems set to continue -- and nowhere is that more evident than in the world's largest economy, the US. The surprisingly large 287,000 jump in payrolls last month quieted fears that the economy was losing altitude after a meager 11,000 gain in May.

Through all the ebbs and flows, US gross domestic product has grown by an average 2.1 per cent per year since the recession ended in 2009. That qualifies it as being the slowest expansion of the post-World War II period. But at seven years old and still going, it's also already the fourth-longest.

We are still in post-crisis adjustment.

"There are few excesses" that would suggest the expansion is coming to an end anytime soon, said Allen Sinai, chief executive officer of Decision Economics in New York.

Consumers, the bedrock of the economy, are in very good shape, with household net worth near an all-time high when measured against disposable personal income.

Banks are well capitalized and able to withstand a severe contraction in the economy, according to the Fed's latest round of stress tests released last month.

For their part, Fed Chair Janet Yellen and her colleagues are caught between a desire to normalize policy as the economy has recovered and concern that such a move would undercut the expansion by strengthening the dollar.

After raising interest rates at the end of last year for the first time since 2006, the central bank has repeatedly postponed plans for a second hike and now doesn't look likely to move until December, according to JPMorgan.

One reason for the Fed to hesitate: The risk that weakening corporate earnings will prompt businesses to rein in investment and hiring, slowing overall growth.

Sinai said he has raised his odds of a recession in the next 12 months to a still-low 15 per cent, from 10 per cent previously, on the possibility that profit-pinched US multinational companies will curb spending post Brexit.

The UK economy looks likely to turn down early next year as the results of the EU referendum ripple throughout the country, according to economists at Goldman Sachs Group. The rest of the Europe will also take a hit, but keep on growing.

The International Monetary Fund on Friday cut its 2017 growth forecast for the euro area to 1.4 per cent from the 1.6 per cent it predicted in April, citing the UK's vote. The Washington-based lender sees the region's economy expanding 1.6 per cent in 2016.

Asia as a whole does appear to be stuck in a slow-grinding growth mode.

Though not stellar, such steady growth would still be a marked improvement from 2012 and 2013, when GDP contracted as the region struggled to contain a sovereign debt crisis.

Unlike the US, Europe remains saddled with bad bank loans and elevated unemployment holding back growth. That's being offset by massive stimulus from the European Central Bank, which the IMF said should be expanded if inflation doesn't rise.

"We are still in post-crisis adjustment," said Holger Sandte, chief European analyst at Nordea Markets in Copenhagen. And "we'll be in this situation for a while, maybe three to five years."

The sense of drift is also evident in once high-flying Asia. While it remains the world's fastest expanding region, weaker demand for its exports, lower commodity prices and China's slowdown are dragging output down.

"Asia as a whole does appear to be stuck in a slow-grinding growth mode," said Aidan Yao, Hong Kong-based senior economist at AXA Investment Managers, which had 666 billion euros (US$736 billion) of assets under management at the end of March.

Nobody is in a particularly strong, nor as of now, a particularly weak position.

Much of the slowdown can be pinned on China where record low interest rates and a large fiscal stimulus have so far struggled to gain traction. Second-quarter GDP, due July 15, is expected to show the economy expanded by 6.6 per cent, comfortably inside the government's target range of 6.5 per cent to 7 per cent -- but still its weakest since the global financial crisis.

In Japan, where the economy continues to bump along the bottom, authorities are grappling with the fallout from the yen's almost 20 per cent surge against the dollar this year that has piled pressure on the nation's exporters.

The Bank of Japan is expected by some analysts to unleash additional stimulus when it meets on July 29 and the government is also planning another round of fiscal stimulus.

Looking across the world economy, Citigroup global chief economist Willem Buiter summed up the so-so situation this way: "Nobody is in a particularly strong, nor as of now, a particularly weak position."

- Bloomberg.

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