Global economy strong but money trends cooling
Core inflation stable
Rising energy costs are boosting headline inflation but the Federal Reserve’s preferred core measure remains below its 2% target, at 1.6% in November, unchanged from January. A pick-up is needed to warrant the three quarter-point rate hikes in 2017 suggested by Fed forecasts.
Solid economic growth and a pick-up in producer prices drove a 14.5% rise in industrial profits in the year to November. The profits turnaround has contributed to a recovery in private investment, which rose an annual 4.9% in November after contracting in mid-2016.
Industrial output surged 5.5% in the six months to November, boosted by strong exports. Global acceleration and a weaker yen promise further strength but will the Trump administration demand an end to the Bank of Japan’s bond yield/currency suppression?
GDP rose by 1.7% in the year to Q3 2016, equal to the increase in the US and above “potential” growth of 1.0% (EU Commission). The unemployment rate fell from 10.6% to 9.8% in the year to October – a larger decline than in the US, Japan and the UK.
Old Lady too loose
The Bank of England has maintained lower rates and pushed on with QE despite much stronger-than-expected economic data and a rise in annual broad money growth to 7.8% — an eight-year high. Excessively loose monetary policy risks sustaining higher inflation due to currency weakness.
Average consumer price inflation across the (E71) large emerging economies fell significantly during 2016, reflecting earlier economic weakness and currency recoveries. With Group of Seven (G71) inflation rising, the E7/G7 gap dropped to a two-year low.
Trends to watch:
Falling money growth
Economic strength in late 2016 was signalled by faster monetary expansion earlier in the year. Money measures have slowed since the summer, suggesting that the economy will lose momentum from spring 2017. Hoped-for fiscal stimulus may not arrive until late 2017/2018.
Tighter monetary policy
Strong money growth has revived the economy but has contributed to housing speculation and currency weakness, and is now feeding through to a pick-up in inflation. A rate hike in early 2017 would surprise markets and could relieve downward pressure on the renminbi.
Rising US rates may scupper the Bank of Japan’s attempt to taper QE while targeting a zero 10-year yield. Governor Kuroda may use better economic news as a pretext to raise the yield peg in early 2017 but this may intensify market speculation of an eventual abandonment.
Capital account relief?
A current account surplus of over 3% of GDP in 2016 was swamped by a record capital outflow. With money trends signalling respectable economic prospects, and the ECB set to reduce QE, the capital exodus may slow in 2017, lifting the euro — assuming no political shocks.
Stronger wage pressures
The Bank of England expects wages to lag accelerating prices, undercutting consumer spending. This happened in 2011 but the labour market is much tighter now, while minimum wage hikes are pushing up low-end earnings. A wages shock could trigger an early rate rise.
Indian monetary madness
The Indian authorities cancelled banknotes accounting for 86% of currency in circulation without ensuring a sufficient supply of replacement paper, resulting in a 28% plunge in the M1 money stock. Expect major and lasting economic fall-out unless M1 recovers swiftly.
1E7=Brazil, Russia, India, China, Mexico, Korea, Taiwan. G7=Canada, France, Germany, Italy, Japan, UK, US.
Source: Henderson Global Investors at 31 December 2016. These comments are the views of Simon Ward, Henderson Chief Economist, and should not be construed as investment advice. These views may differ from those of other Henderson fund managers.