Slowdown gathers pace

The declining pace of economic growth has become a truly global phenomenon. Chinese growth continues to outpace the performance in the Western world to a very significant degree, but at 6.2% in the second quarter, it is getting close to the psychologically important 6.0% barrier. The trend towards slower growth should continue in the short run on the back of a cautious policy stance in boosting growth and a difficult international environment. The pace of growth is also slowing in the US, where corporate investment is weakening, although household consumption is resilient. As a welcome exception, Japanese growth has been stronger than expected early on this year, supported by domestic demand. Exposure to China, a subdued outlook for international trade and the fall-out from the VAT increase on consumption paint a challenging picture for the near term. In the eurozone, the good performance in the first quarter (+0.4% growth) was followed by a meagre 0.2% growth in the second quarter. Private consumption has been resilient, underpinned by declining unemployment and dynamic wage growth. Investment has slowed, in part due to the high level of uncertainty. Within the eurozone, the divergence has increased. Germany, where the manufacturing sector is under intense pressure, is probably in technical recession. In Italy, activity is stagnating, whereas the French economy is very resilient. Although growth is slowing in Spain, it remains very satisfactory. Another divergence is between industry and services, with the former suffering more given its higher exposure to international trade.

Central banks have reacted but doubts about the effectiveness

As a consequence, the Federal Reserve and the ECB have reacted by easing policy. This represents probably the biggest sea change compared to expectations about the world economy at the start of the year. Their reaction is very much proactive. In the US, the policy rate is being cut whilst the unemployment rate is at a 50 year low. In the eurozone, the labour market is still robust but concerns about the phase of soft growth lasting longer than expected, which in turn weighs on outlook for inflation and its convergence towards the target, have led the ECB Governing Council to a comprehensive easing package. Critics of this stance have become more vocal considering that the asset purchase programme has been resumed. This reflects concern about the unintended consequences of a prolonged period of very easy monetary policy. It has even led to expressions of disagreement by Governing Council members. The introduction of state-dependent forward guidance, which implies that current policy is maintained (or eased further) as long as inflation hasn’t converged sufficiently, and in a lasting way, to the target has also met with criticism in some circles because it implies interest rates will remain very low and, for some, even negative for quite some time. A priori, this should support growth. Whether this will show up in the numbers depends in particular on confidence, i.e. on a much needed decline in uncertainty.

Economic uncertainty and central bank policy rate