Central banks are reaching the limit

As the closing months of 2016 approach, it is clear that central banks are continuing to take the strain of keeping the global economy on the rails. Throughout the developed world interest rates are at (or close to) record lows, and several central banks are continuing to experiment with avant-garde policy in the hope of stimulating demand by making credit as cheap as possible. Although it is reasonably clear that such policies are supporting growth (while also introducing distortions in asset markets), there is concern that developed markets will not be able to wean themselves off such generous conditions.

The US remains the only major developed economy to have begun a tightening cycle in the past year, and, with a single, 25‑basis-point, rise eight months ago, the start has been tentative. The Economist Intelligence Unit expects no tightening in the UK, the EU or Japan in the next five years. Given that, in value terms, there is more quantitative easing (QE) taking place than ever before, and that bond yields for a growing number of countries and maturities are both at record lows and negative in some cases, it is possible that central banks are reaching the limits of their capabilities. The Bank of Japan (BOJ), which is engaged in the world’s longest-running QE programme, is targeting core consumer price inflation of 2%, yet prices fell by 0.5% in the 12 months to June 2016. The BOJ has tripled the size of its balance sheet since the start of 2012, but in that time economic growth has averaged less than 1% a year.

As it becomes increasingly clear that monetary policy is reaching its limits, we expect more governments to turn to higher public spending. There are few examples of this at present: only the centre-left Liberal Party in Canada is espousing spending on new infrastructure and green technology projects as a way of supporting growth. However, conditions are well suited to more spending. Borrowing conditions are exceptionally benign for reliable sovereigns, and prices for the commodities required for big infrastructure projects are very low. It is possible that Hillary Clinton, should she win the US presidential election, could persuade the next Congress to approve a new infrastructure programme. It is also likely that the previously austerity-led British government will use fiscal policy to try to stave off a Brexit-induced recession. However, for this strategy to be effective, spending has to be new. The Japanese prime minister, Shinzo Abe, announced a fiscal stimulus package in July, but only one-quarter of the headline price tag constituted new spending.

Developed world

The US is in the best position of the major rich-world economies. Although the economy sputtered in the first half of 2016, a tighter labour market, low inflation, strong consumer spending and a turn in the inventory cycle will lead to an acceleration in economic growth in the second half. The market turbulence at the start of 2016 has shown that the slow US recovery is vulnerable to external shocks. We forecast that the business cycle has another three years to run, supported by rising household wealth and the property market. It will turn in 2019 as higher interest rates curb private consumption, resulting in a short recession.

In Europe, confidence will be undermined by existential questions about the future of the euro zone, the rise of national opt-outs from region-wide policy and the struggle to negotiate Brexit, the risk of Grexit, and the migrant crisis. Growth above 1.5% a year looks hard to come by. The fate of Japan is what European governments are keen to avoid. Japanese growth is lacklustre, pulled down by a shrinking workforce, a rising old-age dependency ratio and tight immigration controls. We forecast growth of no more than 0.6% in any year this decade.

The shock of the UK’s decision to leave the EU has now worn off. Nonetheless, we think that the consequences will be long and profound. The mechanism through which Brexit will occur, the legislation governing the UK’s future relationship with Europe and the impact of this new relationship on the global economy are all months or years away from being settled. This will dampen consumer and business sentiment in the world’s fifth-biggest economy, resulting in deferred investment decisions and a year of recession in 2017.

Emerging markets

For most emerging markets, the clouds that were gathering in 2015 have proved to be less threatening than they originally seemed. Expectations of US monetary tightening have diminished and the dollar’s rally has stalled. This has reduced the threat that emerging-market central banks will be forced to raise interest rates and eased concerns about the risk of an emerging-market debt crisis. Instead, many of those central banks have cut interest rates, boosting disposable income. Lower than expected interest rates in the US have also pushed investors towards higher-yielding assets in the emerging world. Furthermore, the emerging-market sell-off of 2014‑15 means that equities, bonds and currencies are now attractively priced. Capital flows into emerging markets, which, remarkably, turned negative in 2015, are back in positive territory. A host of emerging-market currencies have made up ground that was lost against the US dollar in 2015. In the first seven months of 2016 the Indonesian rupiah was up by 5%, the Russian rouble by 9% and the Brazilian Real by 21%. In each of these countries, stronger currencies have reduced the cost of imported goods, supporting domestic consumer spending.

The outlook for emerging markets in 2017‑18 has improved. Stronger capital inflows are supporting currencies and helping central banks to tame inflation. We believe that commodity prices have finally hit the bottom, ending a decline in our weighted index that began in the second quarter of 2011. Over the next two years a slow rise in prices will suit the large number of emerging markets that export raw materials, while importers will still be able to buy commodities at prices that are cheap in historical terms.

We still see two main risks for emerging markets. First, a tightening US labour market could force the Federal Reserve (Fed, the US central bank) to raise rates earlier and more quickly than we expect. (We think that the Fed will raise interest rates by 50 basis points in 2017 and 75 basis points in 2018.) This could encourage capital flows back into the US as rates of return improve. Second, a hard landing in China would send a shockwave through the global economy and turn investors away from emerging markets again.

In China the authorities are finding the ongoing process of delivering a consumption- and services-driven economy hard to manage. The economy is growing at two speeds: the manufacturing sector, plagued by overcapacity and inefficiency, is struggling to expand at all, but the consumer-driven services sector is thriving. As the engine of growth shifts from manufacturing to services, further periods of volatility are certain. We put the risk of China experiencing a hard landing at some point in the next five years at 40%. (We define a hard landing as a drop of 2 percentage points or more in average annual economic growth compared with the previous year.) In India the approval of a nationwide goods and services tax will be a fillip to growth, especially in the long term. It will also boost the re‑election prospects of the prime minister, Narendra Modi. We have raised our growth forecast and now expect it to average 7.5% a year in 2016‑20, from 7.3% previously.

The malaise affecting Latin America has continued for a third year in 2016. The underperformance is being driven by Brazil, where GDP is forecast to fall by 3%. Following a vote in August by the Senate to indict Dilma Rousseff, who was forced to stand down as president in May, we expect Michel Temer, the interim president, to see out the term, which ends in December 2018, and oversee a mild economic recovery. However, we recognise governability risks, including those stemming from revelations in the Petrobras corruption scandal. More broadly, the region’s terms of trade have stabilised as the bear market in commodities has abated. Capital flows have picked up as record low bond yields in the G3 have led investors to search for yield in emerging markets. Venezuela faces a high risk of default. We assume a political transition that will see the president, Nicolás Maduro, leave office early, probably in 2017.

In response to much lower prices, oil producers in the Middle East and North Africa are cutting spending to contain budget deficits while also seeking to diversify economic activity. Saudi Arabia has released a new strategy that aims to end the country’s “addiction to oil”, although it does not address the kingdom’s unpredictable and opaque business climate—arguably the biggest problem facing companies operating in the country. Non-oil economies have received a boost from cheap fuel, which, combined with a stronger Iran, will enable regional GDP growth to accelerate from 2% in 2016 to 3.4% a year on average in 2018‑20. Sluggish growth in South Africa, Nigeria and Angola will continue to depress Sub-Saharan African growth. At 1.7%, the region’s GDP growth this year will be the slowest since 1993. We expect a stronger performance in 2017‑20, but, at 3.2% a year, growth will be below the level needed to propel average incomes and living standards rapidly. Indeed, by 2020, GDP per head at purchasing power parity exchange rates will have barely improved from 2015 levels in many countries.

Exchange rates

Foreign-exchange markets were thrown into turmoil by the UK referendum result. We expect a period of protracted sterling weakness in response to monetary easing by the Bank of England. The US dollar continues to draw support from a relatively attractive yield, compared with those on offer in Japan, the euro zone and the UK. But it remains sensitive to market perceptions about the scale and speed of monetary tightening by the Fed. Given the resilience of the euro following the Brexit vote, we have revised our forecasts for the euro:US dollar exchange rate in 2016‑17: we now expect an average rate of US$1.11:€1 and US$1.09:€1 in 2016 and 2017 respectively. We think that the euro will strengthen to US$1.15:€1 against the dollar by the end of 2020.


Oil prices dropped back in July, with dated Brent Blend, the global benchmark, falling by around 20% from its peak in early June to a four-month low of US$42/barrel on August 2nd. Prices will rise in 2017, when annual global oil consumption will exceed production for the first time since 2013, leading to stock depletion. After years of oversupply, industrial and agricultural markets are moving back towards balance, with our aggregate commodity price index registering its first quarter-on-quarter rise in two years in April‑June.

World economy: Forecast summary
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Real GDP growth (%)
  World (PPP* exchange rates)   3.9   3.3   3.2   3.4   3.1   2.9   3.3   3.5   3.1   3.3
  World (market exchange rates)   2.8   2.3   2.2   2.5   2.4   2.1   2.4   2.6   2.1   2.5
  US   1.6   2.2   1.5   2.4   2.4   1.6   2.3   2.3   1.1   2.1
  Euro area   1.7   -0.8   -0.2   1.0   1.6   1.5   1.3   1.5   1.4   1.5
  Europe   2.1   0.1   0.6   1.6   1.5   1.5   1.2   1.6   1.5   1.8
  China   9.5   7.9   7.8   7.3   6.9   6.6   6.0   5.0   4.4   4.2
  Asia and Australasia   4.2   4.5   4.4   4.0   4.0   3.9   3.8   3.7   3.5   3.3
  Latin America   4.5   3.0   2.8   1.1   0.1   -0.5   1.8   2.8   2.7   3.1
  Middle East & Africa   3.2   3.8   1.8   2.5   2.2   2.0   2.8   3.5   3.1   3.5
  Sub-Saharan Africa   4.6   4.2   4.7   4.4   2.9   1.7   3.0   3.7   3.1   3.1
World inflation (%; av) 4.8 4.0 3.8 3.6 3.3 4.0 4.3 3.9 3.1 3.1
World trade growth (%) 7.1 3.4 3.9 4.0 2.7 2.2 3.0 3.3 2.4 3.1
  Oil (US$/barrel; Brent)   110.9   112.0   108.9   98.9   52.4   43.3   52.5   65.0   62.4   61.4
  Industrial raw materials (US$; % change)   21.7   -19.4   -6.8   -5.1   -15.2   -5.8   7.2   4.8   -5.6   -1.7
  Food, feedstuffs & beverages (US$; % change)   30.0   -3.5   -7.4   -5.2   -18.7   -3.9   2.6   2.2   0.8   -0.5
Exchange rates (av)
  ¥:US$   79.7   79.8   97.6   105.9   121.0   107.1   103.9   107.0   109.1   108.7
  US$:€   1.39   1.29   1.33   1.33   1.11   1.11   1.09   1.11   1.13   1.15
*PPP=purchasing power parity