Macro Weekly – Do politics matter against a background of decent global growth and modest inflation?

by: Han de Jong

  • Trump walks away from Paris Accord, but US business remains committed
  • Theresa May’s lead in the polls is shrinking
  • EN Marche! set to do well in upcoming elections
  • Inflation eases in Europe and the US
  • Confidence data mixed and levelling off, suggesting continued decent global growth
Macro-Weekly-2-June-2017.pdf (165 KB)

Political developments continue to make the headlines. “It was a home run”, was president’s Trump’s summary of his European tour while Germany’s Angela Merkel concluded that Europa can no longer count unconditionally on the US. It is not clear if these to assessments are fully consistent. Meanwhile, the US president has taken his country out of the Paris Climate Accord. The response from US business has been largely negative. Leaders of many US companies have vowed to persist with their efforts to fight climate change. It is very disappointing that the US government has withdrawn from the accord, but that does not mean US business will be stopped. It could be that they will step up and better coordinate their efforts.

In Europe, opinion polls keep moving. The UK elections may produce a less spectacular win for PM Theresa May than initially expected. That will give her a weaker mandate in the Brexit negotiations than she had hoped for.

In France, the polls are suggesting that Emmanuel Macron’s En Marche! will do very well at the parliamentary elections next week and the week after. That will make it easier for the new president to win parliamentary support for his reform agenda. It does not mean, of course, that all his reform plans can be easily implemented. There is always the trade unions which may try to block measures. But at least the new president will have a serious go at strengthening the growth dynamics of the French economy.

The Schulz effect in Germany appears to be disappearing as quickly as it appeared a few months ago. Support for the social-democratic SPD surged when former European parliament leader Martin Schulz was elected party leader earlier this year. But Angela Merkel seems to have found new energy. In fact, she has cleverly made the EU one of her main items, thus stealing that from the SPD. Recent local elections suggest that support for Merkel is strong and, if anything, getting stronger. There is a real opportunity here for Germany and France to take initiatives to progress European integration. That will not be easy, of course. But the realisation that Europe can no longer count on the US implies Europe must do something. And with the willingness on the French side to reform and on the German side to lead, the future for the EU is looking a lot better than it did at the start of the year.

Subdued inflation

The most significant economic numbers of recent days, in my opinion, have been about inflation in Europe and the US. European inflation numbers have been a little volatile in recent months. In February, eurozone inflation had hit the ECB’s 2% target. It fell back in March but jumped back to 1.9% in April, contributing to pressure on the ECB to end its very loose monetary policy soon. Core inflation also showed some volatility recently, jumping to 1.2% in April. That was the highest reading since 2013, leading to some discussion as whether or not inflation pressure is on the rise. My colleague Aline Schuiling has resolutely rejected that view, arguing that the recent pick-up in inflation has been due to the timing of Easter. The May numbers proved her correct. Headline inflation fell back even a tad more than Aline had expected: down to 1.4% while core inflation eased to 0.9%. This data is supportive for the doves within the ECB to keep monetary policy very loose.

Arguably even more interesting were the US inflation numbers. The Fed’s preferred measure of inflation, Core PCE, amounted to 0.2% mom, but fell to 1.5% yoy. It was the second consecutive monthly fall of the yoy rate. Core PCE stood at 1.4 at the end of 2015 and then rose gradually to 1.8% early this year. Many suggested this reflected the gradual rise of inflationary pressures in the US. The recent data casts doubt over the inflation outlook. A price war in telecommunication services is a key factor in the recent decline in the yoy core PCE inflation rate. The question now is whether that is just a coincidence or whether it is an indication of what technology can and will do to inflation.

Confidence measures levelling off

Recent months have been characterised by strong confidence indicators worldwide. But such gauges cannot continue to rise and they are, in many instances at levels that have historically been unusual. The question is what will happen next. The pattern painted by the most recent set of confidence indicators is that they are getting more mixed. But ‘levelling off’ is a better description than ‘coming down’.

The Economic Sentiment Index of the European Commission fell marginally in May: 109.2 versus 109.7 in April. In the US, the Conference Board’s index for consumer confidence fell from 119.4 in April to 117.9 in May, still a very high level. Taiwan’s PMI eased from 54.0 in April to 53.1 in May and in China, the Caixin PMI for the manufacturing sector fell to 49.6 in May from 50.3 in the month before.

But the data is clearly mixed. The PMI produced by the official statisticians in China showed a different picture compared to the Caixin measure. The manufacturing sector’s PMI was unchanged at 51.2 while the non-manufacturing PMI actually strengthened from 54.0 to 54.5. We need to keep a close eye on these Chinese measures. A growth acceleration in China in recent quarters has been a key driving force behind the strengthening of global trade growth. But Chinese policy makers have taken their foot off the accelerator and are tapping the brakes. Indeed, these PMIs had shown a decline in the last few months, so the data from the officialdom are very welcome. There were improving confidence indicators elsewhere too. The eurozone’s Markit PMI rose from 56.7 to 57.0, the US ISM inched higher to 54.9 (up from 54.8), after declining two months in a row. Most impressive was the Chicago PMI, which booked its fourth consecutive monthly gain in May: 59.4, well above its 30-year average of 55.1

All this evidence supports our view that the world economy is growing at a decent though unspectacular pace and that inflation may rise somewhat in the near term, but is unlikely to go out of hand. In such an environment, central banks can operate cautiously. Increasing political uncertainty has the potential to upset financial markets. But this is less so when the economy is doing well. In addition, while there is significant (geo)political uncertainty, developments in Europe could take a turn for the better, which would be a pleasant surprise.