Global economy to gather pace in H2 14 - Danske Bank · •Global economy to gather pace in H2 14...

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The Big PictureGlobal economy re-accelerating

• Global economy to gather pace in H2 14

• US starting to take off as headwinds fade

• Euro recovery to strengthen further in 2015

• China in moderate recovery

• Inf lation in US and euro area bottoms

• Timing of Fed hikes to get more focus

June 2014

Economic Research

2 | June 2014 www.danskeresearch.com

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Contents

Global overview The sky is clearing 4

US Escape velocity 7

Euro area Growth supported by the ECB 10

China Moderate recovery 14

Japan And now for the difficult part 17

The Big Picture is a semi-annual report focusing on the outlook for the global economy. Read about the

perspectives for and the most important risks to the global economy. The publication Nordic Outlook presents

our expectations for the Nordic economies.

Important disclosures and certifications are contained from page 19 of this report.


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Analysts

Editorial deadline: 17 June 2014 Economic Research

Editor-in-Chief:

Allan von Mehren International Economy +45 45 12 80 55 [email protected]

Macro economics:

Pernille Bomholdt Nielsen Euro area +45 45 13 20 21 [email protected]

Allan von Mehren US +45 45 12 82 29 [email protected]

Flemming J. Nielsen Asia + 45 45 12 85 35 [email protected]

This publication can be viewed at www.danskebank.com/danskeresearch

Where no other source is mentioned statistical sources are:

Danske Bank, Datastream, Macrobond, OECD, IMF and other national statistical institutes as well as proprietary

calculations.

mailto:[email protected]

http://www.danskebank.com/research

http://www.danskebank.com/research


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Global overview

The sky is clearing

The global recovery is gaining speed again following a soft spot

earlier this year. The US and China have reaccelerated and the

European recovery continues to unfold although manufacturing is

hitting a soft patch.

Looking ahead, we look for robust global growth in H2 above 4%

with all regions pulling. The positive momentum is expected to

continue into 2015. Our forecasts are slightly above consensus and we

still see Europe as the main candidate for a positive surprise due to

the large amount of pent-up demand and renewed monetary stimulus.

Risks to global growth are generally seen as low as emerging markets

have stabilised. The main risk is a repeat of a strong rise in US yields

as seen in 2013, which could lead to another soft patch.

Inflation is expected to rise gradually from here as global food prices

have increased and falling unemployment will ease the downward

pressure on wage growth. Central banks will keep monetary policy

very accommodative for a long time. This is good for growth but

poses the risk of creating new asset bubbles down the road.

Temporary headwinds are easing

We now have clear signs that the global economy is reaccelerating following

a weak start to the year in both the US and China.

There were three main factors behind the slowdown in the US. First, a

very harsh winter kept consumers inside and added to softness in housing.

Second, inventories started out at a high level keeping production subdued.

Third, the housing market slowed following the sharp rise in mortgage rates

in 2013, which typically works with a lag of six-nine months.

However, all of these headwinds have either stopped or are easing. The

weather effect is over now, the inventory imbalance has eased and the drag on

housing from higher financing costs is slowly reversing as mortgage rates

have declined again. This puts the US recovery on a stronger footing in H2

supported by strong fundamentals: the fiscal drag continues to fade, wealth

gains are very robust, job growth is picking up and real wage growth is

supported by subdued inflation. Also, visibility is the best in a long time as

political uncertainty has declined on both sides of the Atlantic. As a

consequence, businesses are starting to increase investment and hiring and

consumers are spending more. The positive momentum in growth in H2 is

expected to carry over into 2015 where we look for US growth to reach 3.5%.

In China, policymakers have stepped on the gas lately spurring a

moderate recovery. We expect this to continue over the summer and look for

growth around 8% annualised in H2 before moderating again to the

government’s target of 7.5%. Subdued inflation and a cooler housing market

have given the Chinese authorities some leeway to stimulate growth. The

main risk in China continues to be financial instability due to the sharp build-

up of debt in certain sectors and regions. However, overall we believe China

will be able to manage the situation without a system crisis as growth is

GDP outlook: Above consensus

Source: Danske Bank Markets, Bloomberg

US picking up speed again

Source: Danske Bank Markets, Macrobond Financial

China recovering moderately after weak Q1

Source: Macrobond Financial, Danske Bank Markets

% y/yD anske B ank C o nsensus D anske B ank C o nsensus

USA 2,2 2,2 3,4 3,0

Euro area 1,2 1.1 1.9 1.5

Japan 1.7 1,5 1.1 1,2

China 7,4 7,3 7,3 7,2

Global 3,6 3,5 4,1 3,9

2014 2015


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supported by rising productivity and China has high savings as a buffer to

potential high losses from non-performing loans.

We still see scope for positive surprises in Europe

In Europe, the recovery continues to unfold. A very positive development

is the improvement in private consumption. Consumers are now the most

optimistic since 2007 as a the low inflation has given a lift to purchasing

power and unemployment has started to move lower. Uncertainty has been

reduced substantially since the euro crisis ended and the recovery has started

with substantial pent-up demand, which is now slowly being unleashed. We

continue to see potential for upside surprises in the euro area in coming years.

The manufacturing sector is currently hitting a soft patch as exports are

suffering from the weak growth in China and US at the start of the year.

However, this should soon reverse as both countries are regaining speed. The

recent stimulus from the ECB will help to gradually freeze up credit flows,

which is likely to take the recovery to the next level in 2015 where we look

for growth of 1.9% after 1.2% in 2014.

Especially Spain, Ireland Portugal and Greece are surprising on the

upside and have potential for more surprises. These are the countries

where the negative shock hit the hardest; therefore, also where the relief is the

biggest and pent-up demand the highest. The weak link in Europe is France

where house prices are still overvalued and competitiveness is poor.

The UK continues to be the star performer of Europe as the economy has

entered a virtuous cycle where rising house prices and strong job gains are

supporting consumer spending and spurring investments. Although

unemployment has fallen sharply, wage pressures are still moderate, leaving

the Bank of England with patience before raising rates. Macro-prudential

measures to put a dent on the housing market could come very soon though

and are also advisable to avoid another housing bubble from building.

Japan is currently hitting a weak spot following the VAT hike in April.

However, in the context of a global reacceleration, this should prove

temporary and we look for growth to pick up again in Q3.

The list of risk factors is getting smaller

EM have for some time been the biggest risk factor for the global economy as

we have seen several bouts of instability over the past year. However, the

depreciation of many EM currencies in combination with restraint on

domestic demand has helped to repair external imbalances in countries

such as India and Indonesia – two of the big EMs. The weak spots continue to

be Brazil and Russia but things seem to be stabilising here as well. Turkey

and South Africa still have substantial imbalances but they are very small

economies in the grand scheme of things. The risk of a negative outcome in

the Russia/Ukraine crisis has also diminished recently although uncertainty is

still in place regarding this conflict. An escalation with renewed sanctions

could hurt European growth in particular.

Overall, though, the risk picture is improving for the global economy and

the main risk factor now seems to be another sharp rise in US bond yields.

During H2, we expect to see an intensified discussion about the timing of the

first rate hike, which may be a small wake-up call for the markets. If there is

overshooting again, it could cause another soft patch in global growth and

lead to uncertainty in EM markets. However, this is not our main scenario.

Euro recovery gradually strengthening


Euro area consumers getting uplifted

Source: Danske Bank Markets, Macrobond Financial

EM markets supported by Chinese growth

Grey bars show bottoms in China PMI and EM stocks



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Inflation bottoming, central banks stay accommodative

Inflation reached very low levels in not least the euro area but also the US in

H1 this year. A long period of declining commodity prices and subdued wage

growth are the main factors behind the low inflation. However, we believe

inflation is currently bottoming: first, food prices on world markets have

risen around 25% since the beginning of the year, which will likely feed into

global consumer price inflation during Q3 and Q4. Second, as unemployment

declines the downward pressure on wage inflation will slowly fade. Third,

pricing power will improve as the recovery strengthens. We already see signs

that US core inflation has bottomed and we expect inflation to move towards

the Fed’s 2% target over the next year. In the euro area, we look for inflation

to stay very low around 0.5% in the short term but to increase in Q4. The

deflation scare should thus ease a bit. In China, we see some temporary

upside risk to inflation from food in H2 (food is a third of consumer basket).

Central banks are generally expected to keep monetary policy very

accommodative. The ECB has just launched substantial further stimulus and

has solid forward guidance in place indicating rates will stay at zero for at

least a couple of years. The Bank of Japan may have to step even further on

the accelerator in late summer to get inflation higher. The Fed will not start

raising rates until the middle of next year, in our view. While positive for

growth, it leaves concern over the creation of new bubbles. Most assets are

already in expensive territory and with the combination of robust growth and

zero rates in the next couple of years, the risk of new bubbles is quite high.

Macro-prudential measures are needed to avoid these from building.

Expectations for key figures and central banks over coming quarter

Source: Danske Bank Markets. Note latest GDP is Q1 for all countries.

Country Indicator Comment Measure Latest Sep/Q3

USA GDP Growth was surpressed by temporary factors in Q4 and we expect a rebound % q/q, AR -1,0% 3,3%ISM ISM expect to go broadly sideways from current decent level Index 55,4 55,0Employment Job growth to increase slightly in H2 3 mth. mavg. 234k 250kInflation (PCE) Inflation has bottomed and is expected to grind higher % y/y 1,6% 1,7%Federal Reserve Fed continues tapering until it ends in October, first hike seen in mid-2015 % p.a. 0,13% 0,13%

Euroland GDP Positive growth surprises due to pent-up demand and the ECB's support to the recovery % q/q, AR 0,7% 2,0%PMI Manufacturing PMI to increase in Q3 when the impact from the global slowdown vanishes Index 52,2 53,1

Inflation Headline inflation will remain low during Q3 but we look for a pick-up in Q4 % y/y 0,5% 0,5%ECB In our main scenario the ECB will remain on hold, but an ABS programme is likely in Q4 % p.a. 0,15% 0,15%German ifo exp. German ifo exp. has trended lower but remains high and we expect a modest increase Index 106,2 107,3

Japan GDP Recovery poised to lose steam in the wake of the April tax hike… % q/q, AR 6,7% 2,6%PMI ..but Japan is expected to return to growth in Q3 Index 49,9 52,0Inflation Inflation is expected to decline slightly as impact from weaker yen wanes % y/y 3,2% 3,0%BoJ Leading interest rate unchanged until at least 2016 but further QE possible in Q4 % p.a. 0,1% 0,1%

China GDP Moderate recovery in H2 % q/q AR 6,1% 8,5%HSBC PMI Manufacturing PMI is only expected to improve moderately and peak below 52 in Q4 Index 49,4 51,4Inflation Inflation is expedted to increase on the back of higher food prices % y/y 2,5% 2,8%PBOC Leading intereast rate unchanged but PBoC has de-facto easing bias % p.a. 6,0% 6,0%

Euro inflation to stay subdued for long time but

should rise gradually in H2


US inflation and unemployment closing in on Fed

goals, Fed to hike rates no later than mid-2015



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US

Escape velocity

Following years of headwinds the US economy is ready to take off.

While growth slowed a bit more than we expected in the beginning of

the year, we feel confident the outlook is strengthening and the

economy is about to reach escape velocity entering a positive feed-

back loop that keeps the recovery self-sustained.

Easing fiscal headwind, strong wealth gains, rising sentiment and

pent-up demand from investments are among the factors that will

take the recovery to the next level. We look for growth to accelerate

to 3.5% in H2 and 2015. This is above consensus expectations of

3.0%.

As unemployment continues to decline and inflation rises gradually

towards the Fed’s target, we expect the debate on the timing of the

first Fed hike to intensify in coming quarters. We look for the first

hike no later than mid-2015.

Temporary slowdown before take-off

The US recovery came to a halt in Q1 due to bad weather, high inventory

levels in the companies and lingering effects from a sharp rise in mortgage

rates last year that dampened the housing recovery. The slowdown in H1

seems to have been a little deeper than we expected as growth currently looks

set to average 1.0-1.5% – below our estimate of 2% for H1 going into the

year. However, at the same time, the job market has been remarkably resilient

with job gains of around 200k per month and a continued decline in the

unemployment rate. It leaves a picture of poor productivity growth which for

the longer run may be a concern for the US economy. However, in the short

term, it means the economy is still able to create jobs which is giving support

to consumers.

Looking into H2 and 2015, we believe the US economy is heading for a

period of a self-sustained recovery. The economy is, in our view, finally

going to reach escape velocity and break free from the gravity of the

numerous drags that have held back the recovery in recent years. These were

(a) a high level of uncertainty from the euro crisis and political brinkmanship

domestically, (b) strong fiscal consolidation, (c) household deleveraging

following the bursting of the housing bubble, (d) periods of commodity price

shocks, and (e) a temporary ‘bond yield shock’ on the back of tapering of US

asset purchases last year. These drags have kept the recovery at a slow pace

over the past four years in which growth has averaged only 2.5%.

However, all of these drags have diminished sharply, paving the way for

moving the recovery a notch higher. Starting in Q2, we believe growth is set

for a 3.5% pace over the coming years.

Apart from the diminishing headwinds, there is also rising support from a

number of factors.

US recovery strengthening after temporary

moderation in H1

Source: Danske Bank Markets, BEA

Drag on housing from mortgage rates is going to

fade and give new impetus to the housing recovery

Source: Macrobond, Danske Bank Markets

Rising wealth is supporting lower savings



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1. The very low rates and improving economy have led to strong increases

in asset prices in both financial securities as well as house prices. This has

given a significant boost to US wealth and made the average American

more than 20% richer compared with two years ago.

2. Improving sentiment in the corporate sector is likely to lead to more

investment spending after several years of low growth in investment in

new machinery and technology. Rising earnings growth and very low

corporate bond yields also work to underpin business spending.

3. The decline in inflation has given rise to decent real wage growth of

around 0.5-1.0% despite quite low nominal wage gains. This is because a

big part of the decline in inflation has to do with lower commodity prices

related to the rise of oil production due to the shale oil revolution.

4. Pent-up demand in the housing sector should continue to give support to

consumers and construction activity. The construction of houses is still

running far below the level needed to keep the housing stock at pace with

household formation and as the impact of last year’s bond yield increase

fades we expect to see renewed strength in housing in the coming years.

With robust impulses to the economy we also expect job creation to gain

strength and look for an average of 250k in H2 and in 2015. This will be part

of the positive feed-back loop that gives more confidence and income to

consumers paving the way for a lift in consumption growth, which in turn

underpins job creation further.

The main risks to the economy come from the potential for another sharp rise

in bond yields creating a new headwind for the economy as was the case last

year. Our main scenario is for a gradual rise in bond yields by around 50bp

for 10-year yields over the next six months but if the economy moves faster

towards the Fed’s goals, the hiking cycle could move closer and make way

for a stronger rise in yields than foreseen.

Inflation bottoming – wage pressures to rise gradually

After a period of very low inflation in the US, measures of core inflation are

now starting to grind higher. This is partly a result of base effects as health

care costs had a one-off decline in April last year connected to the sequester.

But it also reflects that the downward pressure from commodity prices is

starting to ease a bit as global commodity prices have edged higher recently

following years of a declining trend.

Wage growth is still fairly subdued and certain measures suggest that there is

plenty of slack still in the US labour market (part-time employment, sharp

decline in participation ratio). However, it is uncertain how much of this slack

consists of more marginalised labour because many people have been out of

the labour market for several years. This could imply that wage pressures will

emerge sooner than the Fed expects. For a discussion of this subject, see

Research: How tight is the US labour market?, 6 May 2014.

We look for core PCE inflation (the Fed’s preferred measure) to continue to

rise gradually from the current level of 1.4% towards 2.0% over the next year.

Rising sentiment to boost investment spending


Still pent-up demand in housing


Signs that wage pressures could build soon


http://danskeanalyse.danskebank.dk/link/ResearchUSLabourMarket050514/$file/Research_USLabourMarket_050514.pdf


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The first rate hike is getting on the agenda

With inflation moving higher and unemployment continuing gradually lower,

the Fed will move closer to its goals of 2% inflation and unemployment at the

estimated long-term rate, which is currently at 5.4% according to the latest

projections by FOMC members.

The Fed is very likely to end tapering of asset purchases in October but the

focus on the timing of the first rate hike will likely gain momentum in H2 as

inflation and unemployment continue to move closer to the Fed’s goals. We

look for the first rate hike in mid-2015 and then around 100bp of hikes per

year over the following years. The risk to this scenario in our view is that the

Fed starts earlier and hikes 150bp per year which would correspond to 25bp

per meeting.

Macro forecast – US

Source: Reuters, Macrobond Financial, CBO, Danske Bank Markets

% Change q/q AR Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2013 2014 2015

GDP -1,0 3,3 3,3 3,5 3,5 3,5 3,3 3,5 1,9 2,2 3,4

Private Consumption 3,1 3,6 3,2 3,2 3,6 3,6 3,6 3,6 2,0 3,0 3,5

Private Fixed Investments -2,3 6,9 7,7 7,5 7,4 7,4 7,0 7,0 4,5 3,7 7,3

Residential -5,1 4,1 8,2 9,1 8,2 8,2 6,1 6,1 9,8 2,8 7,5

Non-residential -1,6 7,6 7,6 7,1 7,2 7,2 7,2 7,2 2,7 4,3 7,2

Change in inventories ($bn, real) 49,0 30,0 30,0 35,0 35,0 40,0 40,0 40,0 85,4 36,0 38,8

Change in inventories 1 -1,6 -0,5 0,0 0,1 0,0 0,1 0,0 0,0 -0,4 -0,3 0,0

Public Consumption -0,8 4,1 0,4 0,8 0,8 0,8 0,8 0,8 -0,6 0,0 1,0

Exports -6,0 6,1 8,2 8,2 7,8 7,8 7,8 7,8 2,7 3,8 7,8

Imports 0,8 8,2 8,2 8,2 8,2 9,5 9,5 8,2 1,4 4,2 8,6

Net exports 1 -0,9 -0,5 -0,2 -0,2 -0,3 -0,5 -0,5 -0,3 0,1 -0,2 -0,3

Unemployment rate (%) 6,7 6,3 6,2 6,1 6,0 5,9 5,8 5,7 7,4 6,3 5,9

Inflation (PCE) (y/y) 1,1 1,5 1,6 1,6 1,7 1,8 1,9 2,0 1,1 1,5 1,9

Core inflation (PCE) (y/y) 1,1 1,4 1,5 1,6 1,7 1,8 1,9 2,0 1,2 1,4 1,9

Public Budget 2 -4,1 -2,9 -2,6

Public Gross Debt 2 72 74 73

Current Account 2 -2,3 -2,2 -2,9

Fed funds rate 3 0-0.25 0-0.25 0-0.25 0-0.25 0-0.25 0,5 0,75 1,0 0-0.25 0-0.25 1,0

1: Contribution to GDP growth, 2: Pct. of GDP (CBO), 3:End of period

2015 Calendar year average2014

Rate hike debate in focus as the Fed moves closer

to meet their goals



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Euro area

Growth supported by the ECB

Sentiment continues to improve in the financial market and the real

economy. Domestic demand is recovering despite global weakness.

We expect positive growth surprises as pent-up demand is unleashed.

The recovery is still without credit but the ECB has stepped in, and it

will help banks’ funding situation. If capital constraints are the main

issue behind weak bank lending, the ECB signals it is ready to take

banks’ credit risk through purchases in the ABS market.

Inflation is back at this cycle’s low of 0.5% and we expect it to stay

low until Q4 when upward price pressure from the labour market

and food commodity prices should result in a gradual increase.

The ECB delivered a stimulus package of negative rates and more

liquidity to be injected over the next two years. In our main scenario

of stronger growth and higher inflation this will be the end of easing.

Recovery driven by domestic demand

The recovery in the euro area continues and is driven by growth in private

consumption and investments. Weaker global growth resulted in lower-than-

expected activity in Q1, when the economy expanded 0.2% q/q. Domestic

demand contributed 0.3pp in Q1, up from 0.1pp in Q4. Some of it was due to

higher government consumption but growth in private consumption was also

higher. On the other hand, the weakness in the US and China in Q1 resulted

in lower export growth and net export dragged down growth by 0.2pp after a

positive contribution of 0.3pp in Q4.

The weakness in foreign demand is also reflected in euro manufacturing PMI,

which peaked at 54.0 in January. We expect the lagged effect from the global

slowdown to have a temporary negative impact on the activity indicator

during Q2. The service PMI, which is mostly dependent on domestic demand,

has not worsened and in line with that consumer confidence continues its

upward trend suggesting higher growth in private consumption.

We expect GDP growth to pick up to 0.5% q/q in H2, when exports should

again support the ongoing recovery in domestic demand. Looking further

ahead we believe growth will surprise on the upside as the improved

sentiment will result in pent-up demand being unleashed. There is a gap to

trend growth in both private consumption and investments of 7pp and 20pp

respectively. In a situation where these gaps close within the next four years it

will add around 1.9pp to GDP trend growth. Moreover, growth should

strengthen further, when the credit multiplier normalises and ECB’s easing

package results in lower real rates and a weaker currency, see more below.

The outlook for economic activity in 2015 implies we have revised our GDP

growth forecast up to 1.9% from 1.7% (consensus 1.5%). The weaker-than-

expected activity in Q1 has resulted in a slight downward revision of our

2014 forecast to 1.2% from 1.3% but it is still marginally higher than

consensus at 1.1%.

Recovery driven by domestic demand

Source: Eurostat, Danske Bank Markets

Manufacturing PMI at a plateau due to weak export

Source: Eurostat, Markit PMI

Positive growth surprises due to pent-up demand

Source: Eurostat, Danske Bank Markets


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Stronger growth when credit growth starts to improve

Bank lending to the private sector continues to decline although the recovery

started a year ago and looking ahead higher growth depends on a normalised

credit multiplier. The ECB’s Bank Lending Survey shows credit demand is

increasing slightly but economic activity will only strengthen if there are no

binding constraints on credit supply through the banking system.

The ECB has stepped in and accommodated banks’ funding situation through

a targeted LTRO at a very low interest rate. The TLTRO implies the ECB

will inject liquidity during the next two years if banks’ net lending exceeds a

specified benchmark. However, the TLTRO will not remove loans from

banks’ balances and it is not necessarily sufficient to boost lending. In case

capital constraints are the main lending issue, the ECB signals it is ready to

take banks’ credit risk through purchases in the ABS market.

We expect the cheap funding will be able to improve bank lending as banks

have made capital improvements ahead of the ECB Asset Quality Review

(AQR) and stress tests. Moreover, after the ECB took its snapshot of bank

balances for the AQR, some early signs of improvement have been seen in

lending and this should strengthen further after the review and stress tests.

Virtuous cycles again helped by the ECB

The virtuous cycles in the periphery countries, initiated by the ECB’s OMT

programme in summer 2012, continue and are again helped by the ECB. First

of all, the positive market sentiment has spilled over to consumers and busi-

nesses where it has strengthened growth and improved the debt development.

This has resulted in sovereign rating upgrades, which in turn improves mar-

ket sentiment and gives lower yields. Consequently governments’ funding

costs are reduced, implying less pressure for fiscal austerity measures and less

headwind to growth. The ECB’s easing package has initiated an intensified

search for positive yield, while it should support activity later.

A strong rebound in the periphery would improve debt sustainability

significantly. If annual GDP growth is lifted by 1pp and the primary budget is

improved by an additional 0.5% of GDP the next five years, it reduces the

debt ratio in 2020 by around 10pp for each of the periphery countries. Lower

government funding costs would reduce debt further but the impact will be

gradual as only part of the debt will mature each year. In our view the

virtuous cycles in the periphery countries are likely to continue.

Inflation still very low, we expect it to increase in Q4

Inflation declined to this cycle low of 0.5% in May, see Euro Area Deflation

Monitor. The most recent fall in inflation is a result of lower food price

inflation but looking ahead we expect the trend to reverse as global food

prices in EUR terms have increased by close to 20% since early 2014.

We also expect core inflation to move gradually higher and in Q4 it should be

back around 1.0%. This follows although the nominal wage growth declined

further to 1.2% y/y in Q1 2014. Nevertheless the short-term unemployment

rate, which has been a good indicator for wage pressure during the crisis,

suggests an increase in nominal wages to around 2.0% y/y in 2014. This will

result in the highest real wage growth since the crisis kicked in and should be

positive for private consumption, which is already supported by higher

purchasing power through lower commodity prices.

Credit growth is still not following GDP

Source: ECB, Eurostat, Danske Bank Markets

Virtuous cycles to reduced debt development

Source: IMF (baseline), Danske Bank Markets

Short-term unemployment rate points to higher

nominal wage growth


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2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Italy (baseline) Italy (alternative) Portugal (baseline) Portugal (alternative)

Spain (baseline) Spain (alternative) Ireland (baseline) Ireland (alternative)

Debt in % of GDP

http://danskeresearch.danskebank.com/link/EuroAreaDeflationMonitor160614/$file/EuroAreaDeflationMonitor_160614.pdf

http://danskeresearch.danskebank.com/link/EuroAreaDeflationMonitor160614/$file/EuroAreaDeflationMonitor_160614.pdf


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Given the latest development we have lowered our inflation forecast to 0.6%

from 0.7% in 2014, but we still expect inflation to increase to 1.1% in 2015.

The ECB finally delivered a stimulus package

The ECB announced an easing package containing negative deposit rate,

targeted LTRO with a fixed rate until maturity and a halt to the SMP

sterilisation at the meeting in June, see ECB research: Implications of the

ECB easing measures.

The negative deposit rate has some non-standard effects but overall we expect

it will be growth supportive as it will drive down yields. The mechanism

behind lower yields can be explained as a ‘hot potato’ that is passed between

investors with no one wanting to be the one getting burnt by placing the

excess liquidity at negative rates with the central bank. The search for yield

should also help reduce fragmentation, as strong banks would lend to weaker

banks instead of paying negative rates at the ECB. Eventually, it could feed

through to the private sector and support the weak credit supply, see more in

ECB research #4: Implications of negative rates.

Additionally the more standard effects of ECB’s stimuli will also be growth

supportive as lower real rates will lead to higher growth in consumption and

investments. A stronger recovery should reduce the unemployment rate and

slowly put upward pressure on wage growth and inflation. The easing is also

expected to weaken the exchange rate and support growth through improved

competitiveness, while inflation will also be higher as imported inflation goes

up. As described above, the TLTRO should support bank lending and lead to

higher economic activity.

Given our macroeconomic forecast ECB’s easing measures announced in

June are likely to mark the end of easing. However, if bank lending remains

subdued we expect the ECB to initiate an ABS purchase programme. Another

trigger for easing would be further unexpected declines in inflation but

Draghi said the easing will have a delayed effect on the economy and the

ECB will likely be willing to wait around a year to see the impact.

Macro forecast – euro area

Source: Danske Bank Markets

1. Contribution to GDP growth, 2. Pct of GDP, 3. End of Period

% Change q/q

Annualised rate Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2013 2014 2015

GDP 0.7 1.5 2.1 2.1 1.9 1.9 1.9 1.9 -0.4 1.2 1.9

Private Consumption 0.4 0.8 1.5 1.5 1.5 1.5 1.5 1.5 -0.6 0.7 1.4

Private Fixed Investments 1.4 3.6 3.9 3.9 4.1 4.2 4.2 4.2 -2.8 2.7 4.0

Change in inventories 1 0.2 -0.1 0.1 0.0 0.0 0.0 0.0 0.0 -0.1 0.1 0.0

Public Consumption 1.2 0.8 0.8 0.8 0.1 0.1 0.1 0.1 0.1 0.5 0.4

Exports 1.3 4.1 5.1 5.1 4.7 4.7 4.5 4.5 1.5 3.7 4.7

Imports 3.4 4.1 4.7 4.7 4.6 4.6 4.3 4.3 0.4 3.9 4.5

Net exports 1 -0.9 0.2 0.4 0.4 0.3 0.3 0.3 0.3 0.5 0.1 0.3

Unemployment rate (%) 11.8 11.7 11.6 11.4 11.3 11.3 11.2 11.1 12.0 11.6 11.2

CPI (y/y) 0.7 0.6 0.5 0.9 0.9 1.1 1.2 1.2 1.4 0.6 1.1

Core CPI (y/y) 0.8 0.8 0.8 1.0 1.0 1.1 1.2 1.3 1.1 0.9 1.2

Public Budget 2 -3.0 -2.5 -2.2

Public Gross Debt 2 95.0 95.9 95.2

Current Account 2 2.6 2.9 2.9

ECB refi rate 3 0.25 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.25 0.15 0.15

2014 2015 Calendar year average

A lowering of the rate corridor and boosted liquidity

Source: ECB, Macrobond Financial

Negative rates help growth through lower yields

Source: Danske Bank Markets

Banking system

Bank A

Bank C

Bank BBank D

Negative rates

Real economy

Households

Corporates

Lower yields

Hot potato effect

Leverage effect

Unintended cons.

http://danskeresearch.danskebank.com/link/ECBResearch060614/$file/ECB_Research_060614.pdf

http://danskeresearch.danskebank.com/link/ECBResearch060614/$file/ECB_Research_060614.pdf

http://danskeresearch.danskebank.com/link/ResearchECB4230514/$file/Research_ECB_4_230514.pdf


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China

Moderate recovery

We expect China to recover moderately in H2 14 on the back of easier

financial conditions, mini-fiscal stimulus and improving exports to

developed markets.

We expect growth to lose some momentum again in H1 15, as the

impact of the stimulus starts to wane.

We expect inflation to increase towards 3% y/y in H2 14, on the back

of higher food prices.

The risk of financial stress remains elevated but, in the short term,

the risk has declined substantially due to easier financial conditions.

The yuan is still slightly undervalued and remains on a moderate

appreciation path in the medium term.

Stealth tightening last year has slowed growth

In China, the focus of economic policy has shifted towards structural

economic reforms and containing credit growth since the leadership

transition within China’s Communist Party (CCP) in October 2012 and the

appointment of a new government in March 2013. To rein in the excessive

credit growth, particularly in shadow finance, a number of regulatory tightening

measures targeting shadow finance were implemented last year. In addition, in

spring last year, the People’s Bank of China (PBoC) started to drain excess

liquidity in the money market through its open market operations.

The policy change pushed the money market in particular and broader

financial markets into a state of stress last year. Money market rates surged,

particularly in June and December, and government bond yields also rose

markedly as corporations and smaller banks suddenly faced much more difficult

refinancing conditions. Credit risk premiums also surged in the wake of a

number of defaults on corporate debt and trust products and the corporate bond

market has been fundamentally repriced to discount a higher probability of

default. Hence, overall financial conditions tightened substantially last year, even

though the PBoC kept its main policy instruments – the benchmark interest rates

and the reserve requirement ratio for banks – unchanged. In this sense, it was a

substantial monetary tightening by stealth.

The tighter financial conditions have also been evident in credit growth,

which has slowed markedly since spring last year. Growth in total social

finance, which includes both traditional bank loans and loans from non-bank

sources (shadow finance), has slowed from 22.5% y/y in May last year to

15.2% y/y in May this year . This slowdown in credit growth has been driven

primarily by a substantial slowdown in shadow finance. Some sources of

shadow finance, such as loans from trust funds, appear to have dried out

completely, meaning that corporations such as smaller property developers

that are dependent on these sources of finance are facing very difficult

refinancing conditions when their loans expire and, for this reason, the

probability of default has also increased markedly for these companies.

Moderate recovery in H2 14 but growth could lose

some momentum again in H1 15


Monetary conditions tightened substantially last

year but have eased again so far in 2014


Credit growth has slowed mainly on the back of

slower growth in shadow finance



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Property market is the weakest spot

The tighter financial conditions last year and weaker investment demand have

been the main reason for the slowdown experienced by China since Q3 last

year, although weaker exports have also been a slight drag on growth. A

closer look at investment demand shows weak housing construction, in

particular, has driven the recent weakness in investment demand.

Manufacturing investment has been cyclically weak but has started to

stabilise. Investments within transportation (mainly public infrastructure)

have been resilient and have started to improve probably reflecting that the

government’s mini-fiscal stimulus announced in March has started to kick in.

However, a firmer recovery appears to be dependent on stabilisation on the

Chinese property market.

It does not look like a severe credit crunch yet

So far, it does not look as though China is facing a severe credit crunch.

First, the tighter financial conditions from last year are now to some degree

being reversed. The PBoC has again started to ease monetary policy by

injecting liquidity both through its open market operations and targeted cuts

in the reserve requirement ratio for mainly smaller bank. Although this is only

cautious monetary easing, money market rates and government bond yields

have nonetheless declined markedly in H1 14, meaning monetary policy has

effectively been eased.

Second, most credit risk and stress indicators for China’s financial sector have

improved markedly in recent months, suggesting that the likelihood of a

replay of last year’s money market stress is limited in the short run (see

Monitor: Chinese Credit crunch, 13 June).

Third, the decline in credit and money supply growth has so far been

relatively modest and has stabilised recently. Month-on month credit growth

has also started to pick up as resilient bank loans and very strong corporate

bond issuance have more than offset the sharp slowdown in loans from trust

funds.

Moderate recovery expected in H2 14

The less tight financial conditions should gradually start to support growth

and are likely to be particularly positive for the housing market. At the local

level, some of the restrictions on home purchases and down payment

requirements that have been introduced in recent years are now being eased

where the slowdown in the housing market has been most severe. The

housing market typically responds with a six-month lag to easier financial

conditions. If the usual pattern prevails, sales of new homes should start

improving in Q3 and construction of new homes should start improving in

Q4.

In March, the government announced a mini fiscal stimulus consisting of

frontloaded public infrastructure spending (mainly railways) and construction

and renovation of subsidised housing.

Housing construction has slowed markedly


Decline in money supply growth gas been less than

usual in the recent slowdown


China’s exports have slowed markedly but China

still gaining market share


http://danskeresearch.danskebank.com/abo/ChinaCreditCrunchMonitorJune2014130614/$file/ChinaCreditCrunchMonitorJune2014_130614.pdf


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Finally, exports also appear to be improving, supported in particular by

improving exports to Europe and the US. We expect China’s export growth to

be around 9% y/y in H2 14 and hence China continues to gain market share in

global export markets. This also suggests the Chinese currency remains

slightly undervalued. Hence, we do not expect the recent depreciation of the

Chinese currency to be a more permanent reversal of the appreciation trend in

recent year. The main purpose of the wider daily trading band for the

currency and the recent depreciation has been to deter speculative capital

inflows. We expect the yuan to resume a moderate appreciation path in H2 14

when the economy has stabilised.

Recovery could lose steam again in H1 15

We expect the recovery in H2 14 to be relatively modest and growth will

probably lose a bit of momentum again in H1 15 as the boost from the fiscal

stimulus starts to wane. The implication is that the increase in manufacturing

PMIs will probably be modest again, with a peak below 52 in the

Markit/HSBC in Q4 14.

We expect inflation to increase towards 3% y/y in H2 14, mainly on the back

of higher food prices. This is still below the government’s 3.5% ceiling for

acceptable inflation, so this is unlikely to force the PBoC to adjust monetary

policy although its manoeuvring room will become more limited.

Macro forecast – China

1: % of GDP

Source: Macrobond , IMF, Danske Bank Markets

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2013 2014 2015

GDP, % y/y 7.4 7.4 7.3 7.5 7.6 7.4 7.1 7.1 7.7 7.4 7.3

GDP, % q/q AR 6.1 7.4 8.4 7.8 6.6 6.6 7.8 7.0 7.7 7.4 7.3

CPI, % y/y 2.4 2.5 2.7 2.9 3.0 3.1 3.1 3.1 2.6 2.6 3.1

Public Budget 1 -1.9 -2.2 -2.0

Public Gross Debt 1 22.8 21.3 30.0


I-year benchmark lending rate 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0

2014 Calendar year average2015

China appears to have bottomed out


Inflation poised to move higher in H2 14



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Japan

And now for the difficult part

The recovery is expected to lose steam in the wake of fiscal tightening

but after a brief contraction in Q2 it is expected to return to moderate

growth in Q3.

However, with the boost from monetary easing waning and Japan’s

exports performing poorly, there are mainly downside risks.

It will be difficult for Bank of Japan (BoJ) to reach its 2% inflation

target in H2 15. Hence, further easing is still on the cards, albeit the

likelihood that BoJ will not ease further in 2014 has increased.

With Japan facing considerable fiscal headwinds in the coming years,

BoJ’s exit from the current aggressive QE programme is not expected

to happen sooner than 2016.

This was the easy bit – now for the difficult part

The Japanese economy is entering less certain territory where Abenomics –

the economic strategy of the current LDP-led coalition government – will

really be tested. The first phase of Abenomics has mainly focused on kick-

starting the economy and defeating deflation. The main tools have been

aggressive monetary easing and fiscal stimulus. Japan is now moving into the

much more difficult second phase of Abenomics where focus to a larger

degree shifts to structural economic reforms to the raise Japan’s dismal long-

term growth potential and improve public finances.

The basic idea behind Abenomics is that the first phase should by now have

created a more favourable macroeconomic and political foundation for

improving public finances and implementing structural reforms. Arguably,

Abenomics differs from the austerity-focused strategies in the euro area by its

higher priority on growth and macroeconomic stabilisation in the short run.

The logic is that a more favourable macroeconomic foundation will reduce

the economic costs of budget consolidation in terms of lost output but also

increase the likelihood that structural economic reforms can be implemented

successfully.

Abenomics has so far been a success

So far Abenomics has been relatively successful. Importantly, it has

achieved political stability. The LDP led by Prime Minister Shinzo Abe won

landslide victories in connection with the Lower House election in December

2012 and the Upper House election in July 2013. Together with its coalition

partner, LDP now has a clear majority in both houses and will not face a

major election until 2016. Hence, Japan finally appears to have a prime

minister and government that will be able to last more than one year and face

Japan’s long-term challenges. With Abenomics, Japan at last has a coherent

economic strategy for facing these long-term challenges

Recovery is poised to lose steam in wake of tax hike

but return to positive growth in Q3


Labour market has improved markedly

T

Source: Macrobond

Inflation expectations have increased markedly

T

Source: Bloomberg, Danske Bank Markets


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The first phase of Abenomics that started with the LDP’s assumption of

power in December 2012 has so far been relatively successful. The recovery

has been strong albeit growth has been uneven. The unemployment rate has

dropped markedly to just 3.6% and is now at its lowest level since 2006.

Other labour indicators suggest that the labour market is now the strongest it

has been since the early 1990s.

Consumer prices and inflation expectations have both moved out of

deflationary territory. Inflation surged in April to 3.2% y/y in the wake of

the consumption tax hike. Consumer prices excluding fresh food and the

impact from indirect taxes (the measure that BoJ targets) increased to 1.5%

y/y in April from -0.4% y/y in April last year. Hence, at least on the surface

BoJ within striking distance of BoJ’s 2% inflation target.

Recovery remains fragile

Nonetheless the Japanese recovery remains fragile for several reasons.

First, the increase in inflation has so far mainly been driven by the

weaker yen through higher import prices – particularly higher energy prices.

While there are signs that wage growth is picking up, real wage growth has

remained negative. For BoJ to be successful, it is necessary that wage growth

starts to improve substantially. In light of the tight labour market, it is not

unreasonable to expect that it will eventually pick up. However, in the short

inflation will most likely start to decline slightly again because the impact

from the weaker yen starts to wane.

Second, tighter fiscal policy is poised to be a drag on growth in the

coming years. The blow from the hike in the consumption tax rate in April to

8% from 5% has been softened by higher public infrastructure spending, but

nonetheless fiscal policy will still be tightened by about 1% of GDP in 2014.

The consumption tax will probably be raised again in October 2015 from 8%

to 10% and overall fiscal policy is expected to be tightened by close to 1% of

GDP in both 2015 and 2016. If the government’s goal to balance the primary

budget balance by 2020 is to be achieved, it will probably require that fiscal

policy is also tightened by 1% annually from 2016 to 2020.

Third, monetary conditions (measured by the impact from changes in the

real interest rate, the real effective exchange rate and stock prices) have

become less accommodative (see chart). In other words, the boost to growth

from the aggressive monetary easing has started to wane just as the growth

impact from the fiscal policy turns negative.

Fourth, Japan’s exports have performed extremely poorly despite the

sharp depreciation of the yen since late 2012. Japan has continued to lose

market shares on global export markets and overall Japan’s total exports have

only increased 0.2% since Q4 12. Hence, the recovery so far been driven by

domestic demand. However, it will be extremely difficult to achieve the

ambitious improvement in public finances in the coming years without

support from exports.

Short-term contraction, but return to growth in Q3

Growth in Q1 14 accelerated sharply to 6.7% q/q ann. from just 0.3% q/q ann.

in Q4 13 as consumers frontloaded purchases of consumer durables ahead of

the consumption tax increase in April. Hence, there will be a substantial

payback on private consumption and a slight contraction in GDP in Q2 is

unavoidable.

Difficult to reach 2% inflation target in H2 15


Financial conditions becoming less

accommodative


Japan’s exports continue to lose market share



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The big question is to what degree will the economy be able to recover in Q3.

In our view, the Japanese economy is unlikely to slip into a recession as it

did in 1997 when the consumption tax last was raised. First, the overall

tightening of fiscal policy is less this time. Second, the external environment

is more positive today. In 1997, Asia was in the midst of the Asian crisis,

while the global economy is expected to be in a moderate recovery in the

second half of this year. Third, the domestic economy today is stronger.

Exit from QE not on the agenda until at least 2016

Nonetheless, the recovery is poised to lose considerable steam in 2014 and

2015 and this will make it extremely difficult for BoJ to reach its 2% inflation

target in H2 15 (BoJ’s current projection). If this is the case, BoJ will

eventually be forced to ease further. In the short run, BoJ is unlikely to

respond with further easing on the back of a slight contraction in GDP in Q2.

For BoJ it will be more important to what degree the economy recovers in

Q3. We believe that further easing is possible in Q4 14, particularly if

inflation starts to decline and/or if JPY fails to depreciate further. That said,

with growth probably returning, the likelihood that BoJ does not ease at all in

2014 has admittedly increased.

BoJ is already easing monetary policy aggressively compared with other

major central banks. With Japan entering an extended period with fiscal

headwinds, monetary policy will have to stay extremely accommodative

well into 2016. In our view, exit from BoJ’s aggressive QE programme will

not be on the agenda well into 2016. Fundamentally, this is more important

for our expectations of weaker JPY than a slight increase in the pace of asset

purchases in connection with additional easing. The main risk for our forecast

of a weaker yen is an early exit from the QE in connection with a faster-than-

expected increase in inflation.

Macro forecasts – Japan

Source: Macrobond, Danske Bank Markets 1: Contribution to GDP growth, 2: Pct. of GDP

% Change q/q

Annualised rate Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2013 2014 2015

GDP 6.7 -4.0 2.4 1.0 1.3 1.3 2.3 -0.9 1.5 1.7 1.1

Private Consumption 9.4 -7.8 1.6 1.2 1.2 1.2 2.8 -2.0 2.0 1.6 0.4

Private Fixed Investments 30.2 -2.9 0.9 1.0 1.0 1.0 1.0 1.0 0.2 9.0 0.0

- Residential investment 13.0 2.0 -3.9 -3.9 -3.9 -3.9 -3.9 -3.9 8.8 7.9 -0.6

- Non-residential 34.2 -3.9 2.0 2.0 2.0 2.0 2.0 2.0 -1.4 9.3 6.4

Public Investments -10.5 2.0 2.0 -5.9 -5.9 -5.9 -5.9 -5.9 11.5 3.1 -0.5

Change in inventories 1 -1.7 -0.2 0.9 -0.1 0.0 0.0 0.0 0.0 -0.3 -0.4 0.4

Public Consumption 0.4 0.8 0.8 0.8 1.2 1.2 1.2 1.2 2.0 0.8 0.7

Exports 26.3 4.1 2.0 4.1 4.1 4.1 4.1 4.1 1.6 8.1 6.7

Imports 27.6 -3.2 1.6 1.6 1.6 1.6 1.6 3.6 3.4 10.6 6.9

Net exports 1 0.1 1.2 0.1 0.4 0.4 0.4 0.4 0.1 -0.2 0.9 0.8

Unemployment rate (%) 3.6 3.6 3.5 3.5 3.5 3.4 3.4 3.3 4.0 3.6 3.4

CPI, excl. Fresh food (y/y) 1.3 3.2 3.0 3.1 3.2 1.3 1.4 2.6 0.2 2.7 2.1

Public Budget 2 -8.4 -7.2 .6.4

Public Gross Debt 2 243 244 245


O/N target rate 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10 0.10

2014 2015 Calendar year average

Japan faces fiscal headwinds

Source: IMF Fiscal Monitor, Danske Bank

BoJ is already easing monetary policy aggressively

Source: IMF Fiscal Monitor, Danske Bank


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Disclosure This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S (‘Danske

Bank’).

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Å s e H a a g e n s e n + 4 7 2 2 8 6 1 3 2 2h a @ d a n s k e b a n k . c o m B j ø r n K r i s t i a n R ø e d+ 4 7 8 5 4 0 7 0 7 2b r e d @ d a n s k e b a n k . co m

Wi v e c a S w a r t i n g+ 4 6 8 5 6 8 8 0 6 1 7w s w @ d a n s k e b a n k . c o m

N i l s H e n r i k A s p e l i+ 4 7 8 5 4 0 8 4 3 3n a s @ d a n s k e b a n k . co m

S v e r r e H o l b e k+ 4 5 4 5 1 4 8 8 8 2h o l b @ d a n s k e b a n k . d k

S ø r e n S ko v H a n s e n + 4 5 4 5 1 2 8 4 3 0

d e N M a r k

C h i e f E c o n o m i s t & H e a d of S te e n B o c i a n+ 4 5 4 5 1 2 8 5 3 1s tb o @ d a n s k e b a n k . d k

L a s O l s e n + 4 5 4 5 1 2 8 5 3 6l a s o @ d a n s k e b a n k . d k

M i k a e l O l a i M i l h ø j+ 4 5 4 5 1 2 7 6 0 7m i l h @ d a n s k e b a n k . d k

s w e d e N

C h i e f A n a l y s t & H e a d of M i c h a e l B o s tr ö m+ 4 6 8 5 6 8 8 0 5 8 7m b o s @ c o n s e n s u s . s e

R o g e r J o s e f s s o n+ 4 6 8 5 6 8 8 0 5 5 8 r j o s @ c o n s e n s u s . s e

M i c h a e l G r a h n + 4 6 8 5 6 8 8 0 7 0 0m i k a @ c o n s e n s u s . s e

C a r l M i l to n+ 4 6 8 5 6 8 8 0 5 9 8c a r m i @ c o n s e n s u s . s e

M a r c u s S ö d e r b e r g+ 4 6 8 5 6 8 8 0 5 6 4m a r s d @ c o n s e n s u s . s e

S te f a n M e l l i n+ 4 6 8 5 6 8 8 0 5 9 2m e l l @ c o n s e n s u s . s e

S u s a n n e P e r n e b y+ 4 6 ( 0 ) 8 - 5 6 8 8 0 5 8 5s u p e @ d a n s k e b a n k . s e

Global Danske ReseaRch

e M e r g i N g M a r k e t s

C h i e f A n a l y s t & H e a d of L a r s C h r i s te n s e n+ 4 5 4 5 1 2 8 5 3 0l a r c h @ d a n s k e b a n k . d k

S ta n i s l a v a P r a d o v a + 4 5 4 5 1 2 8 0 7 1s p r a @ d a n s k e b a n k . d k

Vi o l e ta K l y v i e n e+ 3 7 0 6 1 1 2 4 3 5 4v k l y @ d a n s k e b a n k . d k

V l a d i m i r M i k l a s h e v s k y + 3 5 8 ( 0 ) 1 0 5 4 6 7 5 2 2v l m i @ d a n s k e b a n k . co m

D a n s k e B a n k , D a n s k e R e s e a r c h , H o l m e n s K a n a l 2 - 1 2 , D K - 1 0 9 2 C o p e n h a g e n K . P h o n e + 4 5 4 5 1 2 0 0 0 0 w w w. d a n s k e r e s e a r c h . co m

Global economy to gather pace in H2 14 - Danske Bank · •Global economy to gather pace in H2 14...

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Transcript of Global economy to gather pace in H2 14 - Danske Bank · •Global economy to gather pace in H2 14...