Global economy in full swing
- President Trump kept a promise pushing a tax reform through the Congress. Its impact on the US economy remains a source of uncertainty.
The global economy is in good shape with both developed and emerging markets growing solidly (Figure 1 - see pdf). In Europe, a hard Brexit is seen as less likely after negotiations have moved on to phase two. Japan has revised its GDP growth upwards (1.3 % in 2018) and a sharp slowdown of China’s growth (2018: 6.5 %) became less likely with stronger than expected export growth.
The US economy is expanding at an accelerated pace. GDP growth in Q3 increased to 3.3 % (q/q, annualized) after 3.1 % in Q2, in spite of storm related disturbances. Positive fiscal impulses can support growth in 2018. The Federal Reserve Board has recently raised the GDP projection for 2018 from 2.1 % to 2.5 % (y/y).
President Trump kept his promise and signed the Republican tax reform, the Tax Cuts and Jobs Act, on Friday 22nd of December, after both the Senate and the House agreed on an identical version. The bill makes substantial changes to individual income tax rates and the taxation of business income. Besides other changes, the top individual income tax rate is lowered from 39.6 % to 37 % and the corporate income tax is set at 21 % from 35 % previously. The Joint Committee of Taxation, a nonpartisan committee of the United States Congress, estimates the tax reform to increase the deficit by 1,071 billion USD over a ten-year period (2018-2027), already considering deficit reducing effects of the tax reform’s GDP growth stimulus.
Italy is holding a general election on the 4th of March. The Euro-sceptic Five-Star-Movement (MS5) is leading most opinion polls, expected to gain between 26 and 29 % of the votes. Nevertheless, a centre-right coalition with Berlusconi’s Forza Italia as the dominant party is seen as most likely to win the election. The regional election in Sicily in early November, which is perceived as an important indicator for the general election, has shown exactly this result.
Eurozone: The years of discontent come to an end
- Besides supportive monetary policy and the positive external impetus, the labor market trends, bright sentiment and the credit sector recovery sustain the solid business cycle into 2018.
Confidence in the Euro Area economy is returning after years of discontent. In Q3 2017, quarterly real GDP rose by 0.6 % and in annual terms growth accelerated to 2.8 % (after 2.3 % in H1). Growth is well balanced as private consumption and fixed investment contributed 1.0 % and 0.9 % and net exports added 0.3 % to annual GDP growth (Figure 2 - see pdf).
The manufacturing sector recovered during the last year. In November, industrial production expanded by 3.5 %. Construction activity also recovered rising by 2.5 % in October (y/y, 3 months average).
Sentiment surveys reach multi-year highs in the Euro Area indicating bright business expectations among firms and households. Industrial orders rose strongly by 7.8 % and 7.9 % in Q3 in Germany and Italy.
Sentiment and growth are supported by fast improvements in the labor markets, which have been weak for several years. The Euro Area-wide unemployment rate is about to reach its long-term average (~8.5 %) in 2018. It had declined to 8.7 % until last November. On the other side, labor compensation has not shown a significant upward drift (+1.7 % y/y in Q3 2017).
In addition, the credit sector has been catching up and is increasingly becoming supportive for growth. Loans to the household sector have been accelerating and rose by 7.1 % (consumer loans) and 3.3 % (mortgage loans) in November. The corporate loans have been lagging and started to recover last year (1.8 % y/y in November).
Our newly established Eurozone coincidence indicator (“now-casting” model) signals quarterly real GDP growth of 0.5 % in Q4 2017 and projects sustained momentum in Q1 2018 (Figure 3 - see pdf). The positive impulse will likely be maintained during 2018 and annual GDP growth is expected to linger around 2.2 % for the total of the year.
CEE: Goldilocks economics
- We have upgraded the growth outlook for the CEE region in 2018 und included forecasts for 2019. Macroeconomic tailwind is set to persist over the projection horizon.
Central European (CE) economies continue catching up to the European core (see table below). The countries show solid macro-economic performance with exceptional GDP growth. Poland and the Czech Republic, in particular, surprised to the upside with 5.2 % and 5 % annual, seasonally-adjusted GDP growth in Q3 but also Hungary (4.1 %) and Slovakia (3.5 %) experienced their highest growth rates last year in Q3. Household consumption continues to be an important driver of economic growth with investment activity starting to play a more prominent role.
Interestingly, however, the non-Eurozone central banks of the CE region show very diverse monetary policy trajectories. While the Czech National Bank has already increased interest rates twice in 2017, the National Bank of Poland has kept its monetary policy unchanged so far and intends to do so until the end of 2018. The National Bank of Hungary has further eased monetary policy in spite of rising inflation.
Economic growth is exuberant in Romania (8.6 % in Q3 2017) and the central bank embarked on an interest rate hiking cycle last week (see detailed report below). Strong wage growth fuels prices such that inflation was already well above the central bank’s target.
South Eastern Europe (SEE) shows a more mixed though overall sound picture. High unemployment rates in many SEE economies remain a major problem, even though they are declining. In 2018, unemployment rates will remain above 20 % in Bosnia & Herzegovina, Macedonia and Kosovo. Construction activity (Montenegro, Albania) and easier credit availability (Albania, Kosovo, Macedonia) are important growth drivers.
Central Banks: Confidence
- In December, the US Fed’s economic projections outlined a stronger labor market and higher GDP growth.
- Long-term confidence of the ECB to reach the inflation target is mitigated by a soft short-term inflation trajectory.
A significant reduction in economic slack gives the European Central Bank (ECB) ground for greater confidence that inflation will converge towards the inflation goal. At the same time, price pressures remain muted overall. An ample degree of monetary stimulus will remain and be gradually lifted during 2018. The ECB macroeconomic projections forecast Eurozone GDP growth of 2.3 % and subdued inflation of 1.4 % for the year.
The ECB‘s net asset purchases (‚QE‘) of 30 bn EUR per month are intended to run until September and most likely will be gradually adjusted towards zero afterwards. Hence, there is some chance that the ECB will start an interest rate hiking cycle in 2019.
US treasury interest rates might rise gradually over the course of 2018 (Figure 4 - see pdf). The Federal Reserve is set to continue a rate hiking cycle. In the 3rd step in 2017 and the 5th step in total, the Fed raised the key interest rate to 1.5 % in December last year. Two or three further steps (each 25 basis points) are indicated for this year as well as for 2019. The central bank’s guidance is based on a solid growth of the US economy (2.5 %), a very low unemployment rate expectation (3.9 %) and a stable price development (1.9 %) near the Fed’s inflation objective in 2018. The fiscal easing by the Trump tax reform might pose some upside risk to growth and inflation. In addition, the reduction of the Fed’s balance sheet over time that started in October, might assert some upward pressure on the US yield curve. In a staff paper, the Fed had estimated a term-premium effect of 15 basis points for 2018 upon the redemption of the portfolio of balance sheet holdings.
Romania: Second CEE central bank to raise key policy interest rates
- The National Bank of Romania increased its key policy rate by 25 bp to 2 %.
- We expect inflation to have reached 3 % in Q4 2017 (3.2 % in November); 0.3 %-points above the latest NBR’s projection (November).
- Double digit growth of wages and unit labor costs in Q3 2017 have already indicated domestic price pressure to emerge.
- The 3-months interbank interest rate (ROBOR) has picked up significantly since September.
At its board meeting on the 8th of January, the National Bank of Romania (NBR) decided to raise its key policy rate by 25 basis points (bp) to 2 %. This is the second central bank in the CEE region, after the Czech Republic, to raise its key policy rate. The inflation-targeting central bank reacted to accelerating price pressure. In November, inflation was at 3.2 % (y/y), after 2.6 % in October and 1.8 % in September. The inflation target is set at 2.5 % with an upper band at 3.5 % (Figure 1 - see pdf).
With the next inflation projections being published in early February, the central bank acted based on the November inflation report. In November, the NBR expected inflation to be at 2.7 % in Q4 2017. The recent acceleration of consumer prices, however, suggest inflation to be 3 % in Q4 2017 and 1.3 % (y/y) for the whole year of 2017. Hence, domestic price pressures have emerged at a faster pace than the NBR expected, which motivated the central bank to increase its key policy rate for the first time since July 2008.
Inflation is driven by a broad set of product groups, with core inflation being the main contributing factor. The NBR’s CORE2 inflation measure was at 2.6 % (y/y) in November, after 2.1 % in October and 1.8 % in September. However, domestic price pressure to emerge can hardly be seen as a surprise. The Romanian economy expanded by 8.6 % (y/y, sa) in Q3 2017 after 6.1 % in Q2 and 5.8 % in Q1. At the same time, strong growth in gross wages (14.8 %, y/y, Q3) and unit labor costs (10.9 %, y/y, Q3) have already indicated increasing upward pressure on prices (Figure 2 - see pdf).
Hence, the National Bank of Romania can hardly be seen as proactive. Monetary conditions even became less accommodative well before the NBR tightened monetary policy. The 3 months interbank rate (ROBOR) went up by 90 bp already between mid-September and the beginning of 2018, so well before the NBR decided to increase its monetary policy rate. Credit growth shows a first halt in its upward trend. Loans to non-financial corporations expanded by 5 % (y/y) in October and November after 6.4 % in September. A similar pattern can be seen for consumer loans while housing loans regained some momentum lately (Figure 3 - see pdf).
Given the full swing of the business cycle, the strong wage growth and the significant increase in interest rates well before the NBR’s first rate hike, the Romanian sovereign yield curve did not shift upwards as a reaction to the central bank’s decision. The next interest rate decision will take place on the 7th of February when new quarterly inflation projections will be available. Another 25 bp rate hike is likely to follow in the months ahead.
The Polish central bank, kept its interest rates unchanged with the reference rate at 1.5 %. Our analysis of the Polish case from the 11th of December (UNIQA Capital Markets Weekly) is still up to date with core inflation remaining just below 1 % in November (0.9 %, y/y).
Authors
Martin Ertl Franz Zobl
Chief Economist Economist
UNIQA Capital Markets GmbH UNIQA Capital Markets GmbH
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