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Macro View: Secular stagnation raises fears of new global slowdown

Secular stagnation will ensure that interest rates stay well below their historical averages for a very long time

EARLIER hopes of economic improvement in 2015 are giving way to new concerns that we may face an unpleasant mixture of slowing growth and market setbacks. Such a pessimistic outcome is not yet a foregone conclusion. The stock markets are still strong. But the previous upward momentum has given way to an aimless drift and, in some cases, a downward tendency.

The long-lasting uncertainty over the timing of the next Federal Reserve interest rate rise remains the main short-term focus of market attention. But there are now more fundamental fears that the world is experiencing a slowdown, due to long-term factors such as demographics and technology, and this will result in a prolonged period of low interest rates. While this “secular stagnation” will not prevent official rates from rising modestly above their ultra-low levels, it will ensure that interest rates stay well below their historical averages for a very long time.

Not everybody agrees. Some analysts question the view that secular stagnation is a reality. They believe that the main problems facing the world economy are caused by the unconventional techniques employed by the central banks which, instead of stimulating growth, are holding it back by causing financial bubbles, distortions and instability. A few of these criticisms are too extreme. It is unfair to blame the central banks for the low growth since 2009. But it is undeniable that quantitative easing (QE) and similar methods have not restored economic dynamism and entail future risks.

The policy divide between the central banks is now very stark. At one end, the Fed has signalled that its official rate would rise in the next few months, even though the timing remains uncertain. Even after the very weak March labour market figures, a US move well before Q1 2016 is still highly likely. At the other end, the Bank of Japan and the eurozone are pursuing QE programmes that are already very aggressive, and both appear determined to expand their respective balance sheets even further, until domestic inflation is higher.

While QE has been unsuccessful in boosting growth and inflation, its effects on the currency markets have been noticeable. The rises in the US dollar against the euro and the yen over the past year have been driven by divergences in monetary policies. These movements have not transformed the fortunes of the various economies, but they have eased recession risks in the eurozone and Japan. In effect, we are seeing a forex war orchestrated by the central banks, which might have caused global tensions in different circumstances. But, sensibly, the US is so far reacting in a relaxed manner. Since the dollar fell for years after the financial crisis, in response to the more aggressive QE adopted at that time by the Fed, the US can afford to allow the dollar to recoup some of its historical losses, and in doing so support two of its main trading partners. While this game can become dangerous, if political hostility to a strong dollar builds up in the US, global economic relations remain benign so far.

Slow progress

The eurozone, in spite of deep underlying problems, is now making slow progress, while other regions are experiencing setbacks. Our eurozone growth forecasts have been revised up and, although they are lower than in the US, they are moving in a positive direction. But it is important not to disregard the obstacles. Tensions with Russia threaten to damage the economy and reverse the improvement in confidence. Greece’s debt problem is an ongoing sore, and the fundamental differences with the country’s creditors seem irreconcilable and preclude a long-term solution. The best one can hope for are repeated doses of temporary relief that buy more time but do not tackle the issues.

Deflationary pressures have eased to -0% – still too low but less so than earlier in the year. The eurozone unemployment rate edged down to 11.3%, still twice as high as in the US and the UK but a modest improvement. To sustain this slow convalescence, it is critical that the ECB’s expansionary QE programme receives widespread political support. But Germany’s reservations, and lack of full trust between Angela Merkel and Mario Draghi, will hamper the ECB’s effectiveness.

US economic performance has been most disappointing recently. After GDP growth in Q4 2014 was confirmed at a mediocre 2.2%, less than half the 5% rate in Q3, the markets were shocked to learn that the US created only 126,000 jobs in March 2015, well below expectations. In addition, earlier estimates for January and February have been revised down by a further 69,000 jobs. Even after the poor March labour market report, the US created an average of 197,000 jobs per month in Q1 2015 – respectable but not spectacular. The jobless rate was 5.5% in March, the same as in February and very low. So it is premature to talk about a cooling labour market. But the Fed will reconsider its timetable. By dropping her pledge to be “patient” before tightening policy, Fed chairwoman Janet Yellen gave strong hints recently that a June rise in Fed rates is likely. But in the light of the March jobs figure, the Fed could prefer to wait a little longer.

In the UK, the main risk is a huge external deficit. In Q4 2014, the current account deficit was 5.6% of GDP, down from 6.1% in Q3 2014, but still an unsustainable and risky level. In contrast, UK growth is satisfactory, and earlier estimates have been revised up. In the fourth quarter of 2014, GDP growth was revised up from 0.5 to 0.6%, and year-on-year growth was raised from 2.7 to 3.0%. For 2014, compared with 2013, GDP growth was upgraded from 2.6 to 2.8%. The labour market is strong, with falls in unemployment and steady increases in employment.

But there is no evidence yet that the economy is overheating. Wage increases, though edging up gradually, are still modest. Inflation has fallen to 0.0% in February 2015, a new historical low. In the next few months, UK inflation is likely to fall into negative territory, before returning to a positive level before the end of the year. While there is no risk of a long period of UK deflation, the recovery is fragile and must not be put at risk with premature tightening. UK business confidence will benefit from a commitment from the MPC that it will not raise official interest rates until at least early in 2016.

David Kern of Kern Consulting is chief economist at the British Chambers of Commerce. He was formerly chief economist at NatWest Group

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