Special Issue Focus - Four Reasons for Optimism in 2018







Global economic conditions became progressively more positive during 2017 with world GDP growth estimated at 2.9 per cent, a marked improvement on 2016’s sluggish 2.4 per cent. This momentum looks set to stretch into 2018, with our forecast being for world GDP growth to firm further to 3.2 per cent, its fastest pace since 2011. We have identified four key themes for assessing the outlook for 2018 and the risks surrounding it.

1. Global trade growth to remain robust

An upswing in global trade growth was a key driver of and propagation mechanism for the world upturn of 2017. Initially, rising demand from China was the key factor (both directly and indirectly) behind stronger world trade growth. However, as 2017 proceeded, the world trade recovery broadened, encompassing most of the major economies and regions.

We expect Chinese demand growth to slow this year, albeit only modestly, and world trade growth will decelerate a little from 6.0 per cent in 2017 to 4.6 per cent in 2018. However, this year’s pace of world trade growth will still look strong compared to the 2.0-3.0 per cent annual pace seen on average during 2012-2016.

Our forecast is supported by key leading indicators of world trade; The Oxford Economics global export indicator, based on survey evidence from several major economies, leads world trade by around three months – it rose in November and is consistent with world trade growth continuing to run at around a 5.0-6.0 per cent annual pace in early 2018 (see Chart 1).

Robust trade growth is also feeding into stronger investment; capital goods orders from the major economies have picked up well over recent months and are now rising at around 5.0 per cent, annually, having stagnated in much of 2016-early 2017. Firmer investment is good news for the durability of the global upturn.

2. Inflation to remain under control

Upside surprises to GDP growth are usually accompanied by upside inflation surprises, as well. However, this was not the case in 2017, when stronger-than-expected growth in the advanced economies came in alongside lower-than-expected inflation.

In our view, this outcome reflects a number of factors that are likely to remain in place in the near-term, keeping inflation pressures subdued. In particular, wage growth in the major economies has been fairly soft over the last year, despite falling unemployment, and we think this will remain the case.

A key reason for this is that conventional measures, such as headline unemployment rates, understate the degree of ‘slack’ in the labour market. In the Eurozone, for example, a broad measure of slack, including underemployed and discouraged workers, is almost twice as high as the official unemployment rate (see Chart 2).

There is also some tentative evidence that improving economic conditions may be pushing up participation rates in the labour market, which would also tend to restrain wage pressure. After falling sharply in the eight years to 2015, the participation rate in the U.S. has stabilised, and it has even picked up when adjusting for the ageing of the population.

With measures of capacity utilisation in industry across the G7 economies still somewhat below their 2000-2007 averages, there also looks to be a degree of slack still in the corporate sector. The upshot of all this is that central banks are unlikely to raise interest rates rapidly in the near future. We expect three 25 basis point rises by the U.S. Fed in 2018 but no increases in Japan, the UK or the Eurozone (although unconventional policy will be wound down in the Eurozone from late 2018). We expect 10-year government bond yields to rise by 30-40 basis points in the U.S. and Europe by the end of 2018.

3. Emerging market upturn to continue

The fortunes of Emerging Markets (EM) are closely aligned with external factors. In 2017, we saw favourable external factures, such as higher commodity prices, rising world trade growth and a weaker dollar, which boosted EM growth.

The external backdrop will be a little less positive this year with commodity prices flatlining or dipping slightly, and world trade growth moderating. However, the overall external environment will still be broadly positive and is unlikely to be soured by the modest rise we expect in U.S. interest rates. Domestic impulses look supportive, too, with domestic credit conditions improving and scope for looser fiscal policy in some countries.

Aggregate EM growth will also benefit from ongoing recoveries in some large countries, such as Brazil and Russia. Indeed, 2018 is likely to see a notable closing of the ‘growth gap’ between commodity-exporting and manufactured goods-exporting EMs. We expect overall EM growth to rise from 4.5 per cent in 2017 to 4.7 per cent this year. Within this total, manufacturing-oriented EMs will see growth remain around 5.0 per cent, while commodity-oriented EMs will see their growth improve from just 1.8 per cent in 2017 to near 3.0 per cent this year.

4. Political issues not likely to be game-changers

As we enter 2018, economic risks are more balanced than they have been for several years and perhaps even slightly tilted towards the upside. However, concerns about possible policy errors by central banks or a sharp Chinese slowdown continue to feature among risks identified by Oxford Economics’ surveys of its clients.

A number of political risks also remain prominent. The most notable of these are geopolitical risks connected to North Korea and political risks in the Eurozone, connected to Catalonia and Italy or the Brexit process.

However, one lesson learned from the last couple of years is that the domestic economic costs of political uncertainty are often overplayed, and that the regional and global spillover effects are typically far from disastrous.

Even in the Eurozone, financial market contagion connected with political issues has been very limited, with any spikes in government bond spreads proving short lived.

Reflecting on this, while we acknowledge that political factors pose some downside risks to the European economy, our baseline view is that European growth will come in ahead of consensus expectations.

Globally, in the absence of a North Korean conflict or major trade war, we see political uncertainties being felt only at a country, rather than a regional or global, level.

This update was researched and written by Oxford Economics, 121 St. Aldates, Oxford, OX1 1HB, England, as of 18 January 2018.