Consequently, the US Federal Reserve (the Fed) appears intent on maintaining the steady reduction of quantitative easing (QE). A broadening of economic strength in the UK and mainland Europe is not being accompanied by renewed inflationary pressures.
While this allows the Bank of England to maintain its easy monetary-policy stance, in Europe the pressure is mounting for unconventional measures. In Japan, we await the effects of tax increases, but remain optimistic that Abenomics has changed the attitude of the population with respect to the economy, making medium-term success more likely.
Despite this favourable backdrop, market optimism remains dampened by worries in emerging markets. Here, periodic mini-crises have forced central banks to take aggressive action to shore up their currencies, often at the expense of the outlook for domestic growth.
This course of events was initially set in motion by the promise of QE tapering in mid-2013, and as the Fed continues to slowly take away the punch bowl, it appears that further hurdles will need to be overcome.
Continued attempts to rebalance the Chinese economy add another interesting layer to the story. It will involve a careful restructuring of the financial system, a process that has the potential to undermine the growth outlook.
Given the importance of the emerging economies, and in particular China, to global growth in recent years, these developments will need to be watched very carefully as the global economy continues to feel its way out of the recent crisis.
No longer “playing with fire”
A fifth consecutive positive quarter for the UK and an increase in the year-on-year growth rate to over 3% is good news, although the fact that the level of real GDP is still 0.6% below the end-2007 peak provides some context.
A fall in inflation to 1.6% will likely be the trough for this cycle but the medium-term outlook appears benign and certainly supportive of the MPC’s (Monetary Policy Committee’s) second phase of forward guidance, which sets out to keep rates at current levels until spare capacity is taken up.
While growth is currently robust, it does not appear to be accelerating. On the margin, survey evidence suggests some minor cooling in the pace of activity.
Now the recovery is established, the focus of policymakers and the market has moved on to the issue of capacity and the potential for the economy to grow without threatening the inflation target. This is not an easily measured variable, and views are divergent. A focus on the labour market, however, suggests plentiful spare capacity.
This is despite the recent decline in the headline unemployment rate, as a result of the high number of underemployed.
Consequently, we expect the MPC to be very slow to raise interest rates, instead initially using macro prudential tools to target any overheating in the property market.
GDP in 2014 and 2015 is likely to benefit from an improved real income picture; although aggregate income will be crimped by the quality of the jobs being created and subdued average earnings growth. Investment spending has started to make a positive contribution to GDP after a prolonged slump, and widespread survey evidence suggests that this should continue in the coming quarters.
The scale of the increased contribution in official forecasts looks stretched. Fiscal policy will exert a drag on growth towards the end of the forecast horizon, but the medium-term challenges to the optimistic growth outlook revolve around the assumption of a normalisation in trends in average earnings and consumer-debt accumulation.
