Annual Economic Outlook 2016 This marketing document is exclusively for use by Professional Clients and Financial Advisers in Continental Europe, Qualified Investors in Switzerland and Professional Clients in Dubai, Jersey, Guernsey, Ireland, Isle of Man, Malta and the UK. It is not for consumer use. Please do not distribute.
John Greenwood Chief Economist, Invesco Ltd.
Summary – With the US Federal Reserve (Fed) starting on a series of fed fund rate hikes from 16 December 2015, US money and credit markets will be on the path towards normalisation after seven years of abnormally low rates. This is a sign that, despite the weakness in other developed and emerging economies, the US is back on the road to normal growth. – However, the key indicator to watch will be the rate of growth of bank credit. The US is the only major economy where bank credit growth has returned to normal (6-8% p.a.) and it is critical that, in the aftermath of interest rate hikes, credit continues to grow at roughly the same rate. If this happens, then equity and property markets can shrug off the early phase of interest rate hikes in my view. – Assuming no tightening of credit conditions, I expect US real GDP growth in 2016 of 2.6%, and CPI inflation of 1.4%. – By contrast, the Eurozone and Japan are still in the midst of extended programmes of quantitative easing (QE) intended mainly to keep interest rates low along the length of the yield curve (rather than directly to boost the rates of growth of money and credit), and hence to stimulate the two economies. – With the Euro-area likely to grow at only 1.5% in 2016 and Japan at 1.3% and with inflation in both economies well below 2%, the European Central Bank (ECB) and the Bank of Japan (BoJ) are at least a year, if not more, from hiking interest rates in my opinion. In both cases there are faults in the design of their QE programmes that need to be rectified in order to make them more effective. – The upswing in both the economies of the Eurozone and Japan have slowed somewhat in recent months, demonstrating that the underlying recoveries in the US and the UK are inherently more sustainable than the - as yet - fragile upturns in the Eurozone and Japan. – The divergent monetary policies of the Fed and possibly the Bank of England (BoE) on the one hand and the ECB and BoJ on the other implies some further volatility in the currency, fixed income and equity markets. – In particular, the US dollar will probably appreciate further while the euro and the yen might depreciate more. This may weaken the earnings of large US companies with substantial overseas sales, but medium and smaller-size US companies should benefit from the broadening domestic recovery. – The overall picture globally is one in which both growth and inflation will remain subdued against a background of several years of very low money and credit growth. – The UK is faced with a similar situation to that in the US - reasonably buoyant economic activity (I forecast 2.4% growth in 2016), but accompanied by inflation well below target. This implies that the BoE are unlikely to follow the Fed in raising interest rates until February or May 2016 at the earliest. – In the emerging economies the slowdowns in China, Brazil and Russia are continuing to impact commodity markets, numerous basic industries and global trade volumes. Beyond that, the struggle among emerging market (EM) producers more generally to regain competitiveness threatens several EM currencies with the need for further currency depreciation. Trade-weighted value of US Dollar against major currencies
Figure 1 US dollar likely to appreciate further Trade-weighted value on the US Dollar 02
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14 115 110 105 100 95 90 85 80 75 70
Source: Macrobond as at 16 December 2015.
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Annual Economic Outlook
– The emerging economies face three key problems. First, many of them allowed excessive rates of growth of money and credit in 2009-13; second, most are still overly dependent on an export-led growth model; and third many of them are very dependent on commodity exports at a time when commodity prices have slumped. – Following the temporary recovery in the price of oil between March and May 2015 to US$6065 per barrel, prices fell again in Q3 2015 and Q4 2015, with the West Texas Intermediate oil price falling below US$40 per barrel in December. I believe that oil prices will remain weak (below US$60) in 2016. – Inflation rates have continued to remain very low in most developed economies. The widespread inflation undershoot reflects not only the direct effect of weak commodity prices but also the persistent background of slow money and credit growth that has characterised the post-crisis period. Only in the US have money and credit growth rates returned to normal rates. – In spite of these short to medium term setbacks in the recovery process my long-standing view has been that the current global business cycle expansion will be an extended one. The main reason is that sub-par growth and low inflation would avoid the need for the kind of tightening policies that would bring an early end to the expansion. – It is also the case that recessions or growth weakness in the EM economies are unlikely to derail the modest-paced recovery in the developed economies. While some companies or sectors cannot avoid being affected by the problems of the EM, the transmission of key fundamental forces - like monetary policy and balance sheet repair - still goes primarily from developed markets to EM, not vice versa. – In addition, the recovery in the US, although already six and a half years old, is only now starting to take on the typical characteristics of a normal recovery: banks have started to provide credit instead of the Fed, business investment is recovering and consumer spending is regaining its normal momentum. Figure 2 Consensus Economics 2015 Estimate
Real GDP (%)
CPI inflation (%)
US 2.4 0.1 Eurozone 1.5 0.1 UK 2.5 0.1 Japan 0.6 0.8 Australia 2.3 1.6 Canada 1.1 1.1 China 6.9 1.5 India 7.5 5.0 Source: Consensus Economics, Survey Date: 9 November 2015.
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Annual Economic Outlook
2016 Consensus forecasts (Invesco forecast)
Real GDP (%)
CPI inflation (%)
2.6 (2.6) 1.7 (1.4) 1.7 (1.5) 1.1 (1.0) 2.4 (2.4) 1.3 (1.2) 1.3 (1.3) 0.8 (0.8) 2.6 (2.4) 2.4 (2.4) 2.0 (2.0) 1.9 (1.6) 6.5 (6.6) 1.9 (1.6) 7.8 (7.3) 5.3 (5.0)
United States With the gradual healing of private sector balance sheets, US growth is at last returning to normality after nearly seven years of balance sheet-constrained weakness. The weather-induced weak real GDP of 0.6% (annualised) in Q1 2015 was followed by a bounce back of 3.9% in Q2, and a more normal 2.1% in Q3. For the year as a whole average GDP is likely to be 2.4%, above the OECD estimate of current US potential growth (1.6%).
ISM manufacturing index ISM non-manufacturing index
Figure 3 US: Two-speed growth rate US: ISM manufacturing and non-manufacturing indices 08
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15 65 60 55
Since the third phase of QE ended in 50 October 2014 the recovery in the US economy has been hugely assisted by the return of commercial banks to the 45 business of credit creation. For example, since the start of 2015 total loans and 40 leases of US commercial banks have been growing at a steady 8.0%, ample to fuel 35 the liquidity needs of the economy. With the Fed having now started the process of rate normalisation, the key issue will be whether US banks continue to create Source: Macrobond as at 16 December 2015. credit at a similar rate, or whether they curb the rate of credit creation. Credit growth of 8% per annum would be enough, However, the economy is showing signs of a two-speed split, with manufacturing weakening and if sustained, to support nominal GDP services strengthening. For example, industrial production slowed from a year-on-year growth of annual growth of 5-6%. 4.6% in December 2014 to only 0.3% in the year to October 2015, reflecting the decline in shale oil investment in the US, the strong US dollar, and the excess capacity in basic industries abroad, In addition, labour market data have especially in China. Similarly, the ISM index of manufacturing declined to 48.6 in November continued to be buoyant but not showing (indicating a majority of industries were contracting) from 55.1 in December 2014. By contrast, any signs of overheating. For example, the ISM non-manufacturing index has remained above 55 since April 2014. In summary, given the non-farm payrolls increased by an average dominance of the service sector, this adds up to a recovery that is now self-sustaining even without of 210,000 per month for the year to Fed asset purchases, although it is unlikely to become exuberant any time soon in my view. November, and the unemployment rate fell from 5.8% in January to 5.0% in US consumer spending expanded from 60% of GDP in the 1970s to 68% of GDP by the time November. Average private non-farm of the financial crisis in 2008-09, helped by a major increase in consumer indebtedness over weekly hours worked have held steady at the subsequent three decades. Since the crisis spending has remained at roughly 68% of GDP, 33.7 hours, returning to their pre-crisis but households have deleveraged relative to income, putting an effective ceiling on consumer trend. Moreover, growth in average hourly spending. Unless consumers are prepared to start adding to their indebtedness once again, earnings of production and non-supervisory consumer spending will now be limited to the rate of growth of personal incomes. Consistent with workers has averaged fractionally less this analysis, personal consumption spending grew 3.4% year-on-year in Q3 2015, slightly less than 2.0% during 2015 and does not than personal incomes in the year to October 2015 which grew at 4.6% in nominal terms. appear to be showing any clear uptrend. Furthermore, the labour force participation Investment spending also remains subdued, gradually climbing from its post-crisis lows of 13.5% of ratio has continued to decline from 62.9% GDP in 2010 to 16.3% of GDP in Q3 2015. Non-residential private fixed investment surpassed its in January to 62.5% in November. pre-crisis peak in late 2013 and has continued to move gradually upwards, but the corporate sector is still showing a clear preference for financial investment in the form of share buy-backs or mergers and acquisitions rather than investment in physical plant and equipment. Housing investment experienced a particularly weak first quarter, but since then it has continued its gradual recovery, showing a modest improvement over 2014 as measured by a composite of housing starts, permits and completions. These data suggest an economy that is gradually returning to normal rather than surging ahead on the basis of low interest rates. For 2016 I expect 2.6% real GDP growth. On the inflation front consumer prices have continued to surprise most forecasters on the downside, recording a 0.2% year-on-year increase in October 2015, and 1.9% when volatile food and energy prices are excluded. This is usually explained by the fall in commodity prices over the year, especially oil prices, but the truth is that weak commodity prices are a symptom of a weak global economy, which in turn is a result of slow growth of money and credit. With no acceleration in money and credit growth it is unlikely that inflation can rise significantly. For 2016 I forecast a 1.4% increase in headline CPI inflation.
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Annual Economic Outlook
The Eurozone Eurozone real GDP growth has remained anaemic in 2015, slowing from 0.5% quarter-on-quarter in Q1 to 0.4% in Q2 and 0.3% in Q3 (respectively 1.3%, 1.6% and 1.6% year-on-year). However, deflation risks have diminished thanks to the depreciation of the euro since the first three months of 2015 and the eventual adoption of QE policies by the ECB, starting in March. I forecast 1.5% growth for the Eurozone in 2016. For most of 2015 economic activity has been weaker and inflation lower than the authorities at the ECB had hoped, with the ECB revising down its forecasts and President Mario Draghi announcing a modest extension of the QE programme on 3 December. Although the amounts purchased each month by the central bank remain unchanged at €60 billion, the range of assets to be purchased was widened to include provincial or regional authority debt instruments, and the date for ending the asset purchases was moved out 6 months until “the end of March 2017, or beyond, if necessary”. The principal payments on maturing holdings would henceforth be re-invested and the interest rate on the ECB’s deposit rate facility was lowered by an additional 10 basis points to minus 0.30%. As explained in past issues of this publication, the QE programme continues to be less stimulating to markets and the broader Euro-area economy than it should be due to basic design flaws. In the final quarter economic activity may have improved somewhat, as suggested by the small rise in the composite Purchasing Managers’ Index (PMI) to 53.9 in October and 54.2 in November. Across the major economies of the Euro-area the PMIs are generally above the 50 line that separates expansion from contraction, with composite indices for Germany at 55.2 in November, 54.3 in Italy, and 56.2 in Spain. Only France is significantly weaker at 51.0 in November. The German Ifo index of business conditions recorded its highest level for the year (109.0) in November, and has been on a rising trend since October 2014. However, the labour market in Europe continues to make only very slow progress with unemployment falling from a peak of 12.1% in June 2013 to 10.8% in September 2015, contrasting sharply with the steep declines seen in the US and the UK over the past five years. Figure 4 Eurozone: ECB’s QE policy not gaining full traction Eurozone total assets of ECB and deposits in M3 (% YOY) 11
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Total assets of ECB Deposits in M3
15 60 Start of QE
50 40 30 20 10 0 -10 -20
Source: Macrobond as at 16 December 2015. One factor which perhaps should have made a greater contribution to Euro-area growth was the depreciation of the euro from US$1.25 to 1.05 by mid-March, subsequently fluctuating in the range 1.15-1.05 for the rest of the year. Exports from the Euro-area have only picked up since mid-2015, although the growth rate in September was still only 6.3% year-on-year. The main explanation is that without volume growth abroad, price changes alone will do little to boost demand from Europe. Consequently, Eurozone exports, in line with the sluggish performance of global trade in recent years, were essentially static between 2012 and mid-2015. Meantime the current account has moved to a surplus of 2.9% of GDP, mainly due to weak imports. In addition to these cyclical problems, the repair of balance sheets in the Eurozone is proving slow, although given the fiscal squeeze imposed by the authorities this is not surprising. Only in Spain, Ireland and one or two sectors elsewhere such as the German and Italian financial sectors has indebtedness declined relative to GDP. Despite the ECB’s QE measures, the Euro-area is still dangerously close to deflation. In January 2015 the headline CPI had fallen to -0.6% year-on-year, and in November it was still only +0.14%, while the GDP deflator was 1.3% in Q3. Importantly the rate of growth of money and credit in the Eurozone has been improving, but since it takes two years for the full effects of faster money growth to feed through to inflation, it will be another year before positive inflation rates can be assured. Meantime the weakness of commodity prices is having a temporary downward effect on reported inflation. The ECB must therefore encourage faster growth of broad money and credit than it has allowed so far. I forecast the inflation rate of the Eurozone as a whole will be 1.0% in 2016 - still well below target. 04
Annual Economic Outlook
United Kingdom The recovery of the UK economy continued in 2015 but slowed modestly from the strong pace seen in 2014. On a quarter-on-quarter basis, growth accelerated to 0.7% in Q2 2015, or 2.4% year-onyear, but slowed to 0.5% quarter-on-quarter in Q3, or 2.3% year-on-year. As in previous years of this recovery it has been services that have been leading the way, with manufacturing and construction lagging behind. Viewed from the expenditure side, personal consumption has been firm, helped by the decline in the inflation rate which has boosted real wages. However, the fastest growing expenditure component of GDP in 2015 has been capital investment by businesses, averaging 4.7% in real terms over the past four quarters compared with 3.0% for final consumption expenditure. Construction Manufacturing Services GDP
Figure 5 UK: Services leading, manufacturing and construction lagging behind UK: Real GDP by value added (2008 Q1=100) 08
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15 120 115 110 105 100 95 90 85
Source: Macrobond as at 16 December 2015. The contrast between strong services and weaker manufacturing is reflected in the relative performance of the PMI indicators. While the composite PMI index (which includes manufacturing and services but not construction) showed an expansion to 55.8 in November, the manufacturing PMI was 52.7 whereas the services sector recorded an advance to 55.9. Both sets of indicators implied some slowing from the stronger expansion earlier in the year. The key to stronger services and consumer spending has been the gradual upturn in wages, which increased by 3.0% year-on-year (inclusive of bonuses) in the three months July-September in both nominal and real terms (since year-on-year CPI inflation was zero in the those three months), combined with the continuing growth of employment. For example, using the Labour Force Survey data, the number of people in full-time employment increased in the year to July-September by 273,000, and by 146,000 in part-time jobs. Together these figures account for the increased purchasing power shown by UK consumers over the year, though the falls in energy prices towards year end could boost consumer spending even further. As noted, investment spending by businesses has been growing steadily and order books reported by the Confederation of British Industry have been firm, though softening a touch through 2015. Some of the slowdown is probably due to the stronger level of sterling which has appreciated by 9.7% on a trade-weighted basis over the year to December. Reflecting the growth in the number of households and population, as well as the shortage of new houses and apartments coming on to the market, house prices had risen by 5.6% year-on-year in Q3 2015 (according to the ONS mix-adjusted house price index). With the exception of Scotland, Wales and the north-east of England, house prices rose across the board, helped in part by the gradual rise in mortgage lending approvals since the start of 2015. Looking ahead the pace of economic growth is unlikely to change much from here, with a range of surveys and indicators suggesting that growth will be maintained at close to 2.5%. Low rates of money and credit growth over the past three years combined with the strength of sterling will ensure that headline inflation will remain low through 2016. Turning to monetary policy, the BoE will almost certainly not follow the Fed in raising rates for several months in my view. First the reported CPI inflation rate in the UK is much lower than the 2% target level; second money and credit growth are subdued; and third raising rates would tend to strengthen sterling even further – an unwelcome step as far as the authorities are concerned. Given that the Bank tends to adjust rates only after its quarterly Inflation Reports, it seems unlikely that there will be a rate rise in the UK until the May or August 2016 Inflation Reports at the earliest. For 2016 I now expect 2.4% real GDP growth and 1.2% CPI inflation.
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Annual Economic Outlook
Japan The signature policies of Prime Minister Shinzo Abe to revive the economy consist of three “arrows”: a stimulative monetary policy, a reconstruction of Japan’s fiscal accounts and a set of structural reforms. While some progress has been made under the first two parts of the “Abenomics” plan (monetary policy and taxation reform), the third arrow, which emphasises reforms to labour markets, company tax and competition, has been more politically difficult and slower to emerge. First, on the monetary front, although the BoJ has more than doubled the size of its balance sheet by means of bond (and other asset) purchases, the commercial banks have not expanded their balance sheets at a faster pace than previously. At the end of November, Japan’s money supply (M2) had increased by only 3.3% year-on-year, while bank lending had increased by 2.5%. Total bank credit, which includes bank holdings of securities, has actually declined since March 2013 when Governor Kuroda took over at the BoJ. The second “arrow” of Abenomics, fiscal policy, turned restrictive in 2014 when a 3% increase in the consumption tax was imposed from 1 April. Personal consumption spending, which had surged ahead of the tax, plunged - in Q3 2015 it was still below its level in Q3 2013. In a low growth economy like Japan without strong income growth the effect of a 3% tax hike has been painful and sustained. In October nominal retail sales increased by 1.6%, but it is too early to judge if this erratic series points to any sustained recovery of consumer spending. Consensus estimates forecast year-on-year increases in real consumer spending of 1.3% in 2016. Recession
Figure 6 Japan: Real GDP has not yet recovered to its pre-consumption tax level Japan real GDP (at constant prices) 07
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15 540 530 520
Consumption tax
510 500 490
Source: Macrobond as at 16 December 2015.
JPY, trillion
Real GDP growth has been highly erratic in the past three years, in part due to the imposition of the consumption tax, but also due to changes in the value of the yen and its impact on external trade. After two steep declines in Q2 2014 and Q3 2014, the annualised growth of real GDP has been 1.8%, 4.4%, -0.5%, and 1.0%. Industrial production growth has also been highly variable around a very low growth rate compared with the past. With short supply chains in Asia and more rapid changes in consumer tastes it is unlikely that Japan will return to steady, positive growth – even under “Abenomics”. Consensus estimates of overall real GDP suggest growth rates of 1.3% only in 2016, in line with my forecast. The third “arrow”, structural reform, consists of a long list of initiatives proposed by PM Abe’s closest advisers as well as by government departments. Very little of substance has yet been implemented. There are almost certainly substantial gains to be achieved through changes to labour market regulations (including immigration) and enhancing domestic competition with freer entry into industries, improved pricing surveillance and new approaches to regulation. However, vested interests such as farmers, truckers, doctors and other groups of professionals have built strong political lobbies and the PM has not felt able to confront them. On the external front, the depreciation of the yen in 2013-14 is at last starting to impact the trade and current accounts. Both have improved relative to GDP, providing a boost to growth. After the tsunami and Fukushima nuclear disaster the external accounts worsened but the combined effects of a weaker yen and lower commodity prices have turned things around for Japan. Although the trade balance is still marginally in deficit, Japan is now running a current account surplus of close to US$300 billion or 0.75% of GDP. With growth low but erratic and inflation well below the BoJ’s target rate of 2%, the achievements of “Abenomics” are looking distinctly limited.
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Annual Economic Outlook
China and non-Japan Asia Although official figures show that China’s growth remained steady at or near 7% throughout 2015, most observers would consider that the economy has continued to slow. This is partly a problem of perception, and partly of inadequate statistics. There is no doubt that China’s northeast region, where State Owned Enterprises involved in heavy industries such as coal, steel and aluminium smelters are concentrated, have been in recession, overburdened with excess capacity and accumulated debt. This is easy to see both on the ground and in the statistics for commodity prices, freight shipments and falling output. However, the faster growing service and light manufacturing industries of the south-eastern provinces are still growing vigorously, but there are few “hard” data series to confirm this impression. Internet-based services and deliveries are flourishing - as in other economies - but government and private industry sources have few satisfactory data sources to confirm the growth momentum in these new sectors. Official data such as the non-manufacturing PMI, which was 53.6 in November, or the manufacturing PMI which was 49.6 also in November confirm the weakness in manufacturing compared with the relative strength in services. The unofficial Caixin PMIs are broadly in line with these indices, but show a steeper decline in manufacturing (48.6 in November after a recent low of 47.2 in September) and a weaker trend in services (51.2 in November after 50.5 in September). Given the need to deleverage the economy after several years of very rapid credit growth and the slow growth of China’s more developed trading partners, it seems inconceivable that there could be any rapid return to pre-crisis growth rates anytime soon. For 2015, the official growth figures are expected to be 6.9%, according to Consensus Economics, and I forecast 6.6% in 2016. National average Service sector six North China six
Figure 7 China: Wage growth in north-east rust belt lagging the service sector Average wage growth by groups of provinces
(%, y-o-y) Jan 12
Jul 12
Jan 13
Jul 13
Jan 14
Jul 14
20 18 16 14 12 10 8
Source: Macrobond as at 16 December 2015. Since the authorities deliberately devalued the currency from around 6.21 per US$ to 6.386.40 in early August the currency had been held fairly stable in the range 6.30-6.40 per US$. However, since 30 November when the IMF admitted the Chinese yuan to membership of the basket of currencies comprising the Special Drawing Rights (SDR), the currency has been allowed to depreciate more rapidly, reaching 6.46 on 15 December Although the SDR status has symbolic meaning, it will probably not make much difference to foreigners’ day-to-day access to China’s domestic capital markets. It remains the case that China’s future growth and the internationalisation of its currency will be far more dependent on the liberalisation of China’s domestic capital markets and the lifting of its extensive capital controls than on the recent decision by the IMF. Without an acceleration of money and credit growth (which is not desirable while China is deleveraging) CPI inflation is expected to remain low. The most recent reading was 1.5% in November, and I forecast 1.6% in 2016. Among other factors keeping inflation subdued are the continuing declines in commodity prices which have helped push the producer price index down to -5.9% year-on-year in November. The remainder of non-Japan Asia is suffering from the same broad weakness in world trade that has been holding back China’s export engine. However, with only a few exceptions, such as India, Indonesia and possibly Korea, the regional economies do not have large enough domestic markets to provide a countervailing locomotive effect. Consequently the entire region is watching and waiting for progress in the developed economies, especially the US, to begin a more vigorous upturn.
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Annual Economic Outlook
Commodities I have been bearish on the outlook for commodity prices over the past two years. In recent months there have been further significant falls in most commodity markets. Most strikingly the oil price has fallen steeply with Brent crude dropping from US$115 per barrel in June 2014 to US$64 in December 2014 and below $40 in December 2015. This is a direct result of weak demand in China, other emerging economies, and the Euro-area, together with the consequence of new supplies from US shale oil and gas suppliers, plus the decision of OPEC not to cut production. Other industrial commodities have seen comparable price falls. For example, imported iron ore in China has fallen from US$180 in 2011 to below US$40 per metric tonne in December 2015 while Australian coking coal prices have fallen by comparable amounts. Finally, precious metal prices have been declining with gold and silver prices subdued, but steep falls in platinum prices over the past five years, and a 40% fall in palladium prices over the past year. This is all consistent with the relative softness of global demand resulting from the sub-par growth of major economies and the slowdown of emerging economies as they reduce emphasis on export-led growth models. Looking forward, commodity markets are not likely to strengthen over the next year as inflation will remain low and economic activity levels will moderate at best in my view. EM Commodity producers’ exports EM Manufacturing economies’ exports
Figure 8 EM Commodity exporters hit much harder than EM manufacturing exporters Exports of “manufacturing” and “commodity” Emerging Economies (Jan 2009 = 100, 3MMAV) 09
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15 300 275 250 225 200 175 150 125 100
Source: Macrobond as at 16 December 2015.
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Annual Economic Outlook
Conclusion In the financial markets there is a widespread misunderstanding about the stance of monetary policy. Most economists and analysts tend to judge monetary policy by the level or direction of interest rate changes. However, interest rates are not a good measure of the stance of monetary policy. If monetary policy i.e. monetary growth is eased, interest rates will fall initially but later, after the economy recovers and inflation rises, rates will rise. The longer term and more important effect (the “Fisher effect”) of easy money is higher interest rates not lower rates. Conversely, if monetary policy is tightened interest rates will rise initially, but then after the economy has slowed and inflation has fallen, interest rates will fall. So the longer term and more important effect of tightening monetary policy is lower rates not higher rates. That is why interest rates today are highest in countries like Argentina and Venezuela and why interest rates are lowest in countries like Japan and the Eurozone. It follows that what is needed to avoid deflation is faster growth of the quantity of money. It is not enough simply to lower interest rates to zero as the ECB has done. The reason is that by merely following market rates downwards, central banks can remain essentially passive, failing to provide the monetary expansion that an economy needs to grow. The low interest rates in the Eurozone and in Japan are the result of the second phase of a prolonged period of tight money policy - that is, slow money growth - not the first signs of easier - that is, faster money growth. It is hardly surprising that in these circumstances Japan and the Euro-area have been confronted with deflation in recent times. With the Fed in the US moving to raise interest rates (to normalise but not tighten monetary policy) in 2016, the critical issue will be whether money and credit growth can be sustained at 6-8% p.a. (their recent growth rates). If the commercial banks are able to maintain these money and credit growth rates, then even if bond and equity markets are jolted by the initial rate hike(s), the economy will, in my view, be able to shrug off the interest rate hikes, expanding for several more years before the business cycle hits a peak. John Greenwood Chief Economist, Invesco Ltd
Important information This marketing document is exclusively for use by Professional Clients and Financial Advisers in Continental Europe, Qualified Investors in Switzerland and Professional Clients in Dubai, Jersey, Guernsey, Ireland, Isle of Man, Malta and the UK. It is not for consumer use. The value of investments and any income from them will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested. While great care has been taken to ensure that the information contained herein is accurate, no responsibility can be accepted for any errors, mistakes omissions or for any action taken in reliance thereon. Where John Greenwood has expressed opinions, they are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco professionals. All data provided by Invesco, sourced from Macrobond as at 16 December 2015, unless otherwise stated. Issued in Austria by Invesco Asset Management Österreich GmbH, Rotenturmstrasse 16-18, A-1010 Wien Issued in Dubai by Invesco Asset Management Limited, PO Box 506599, DIFC Precinct Building No 4, Level 3, Office 305, Dubai, United Arab Emirates, Regulated by the Dubai Financial Services Authority
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