Quarterly Economic Outlook March 2018 - Highlights

Global growth is solid: risks stem from economic policies

Prometeia's Quarterly Economic Outlook - March 2018 - Highlights

Global economic activity remains healthy, also thanks to fiscal measures approved by the Trump administration, which will support growth in 2018 and 2019. Subsequently, with different intensities, higher in the USA and less so in the EMU, the constraints of output capacity will start to kick in and the world economy will tend to slow down. There are no particular areas of real or financial risk in the short term. Uncertainties mainly stem from possible mistakes in the conduct of economic policies:

  • The Trump administration is preparing to introduce a series of protectionist measures with uncertain implications
  • Fears of a higher-than-expected recovery in inflation could create an excessive response from US monetary policy and create nervousness in the financial markets
  • The debate on European reforms, which is restarting after the formation of the government in Germany, could create uncertainties given the new Italian political situation and the resistance of many North European countries. 

Here are the Quarterly Economic Outlook – March 2018 main forecasts:

  • In Italy, economic activity remains on track, although marginally lower than in 2017 (GDP 2018 +1.4% compared to +1.5% last year), partly due to the moderation of particularly favorable external conditions, including the sustained trend in international trade and the very expansionary European monetary policy. Growth will remain almost stable in 2019 (+1.3%)
  • Slower fiscal consolidation to meet, at least partially, pre-election announcements. The path will still allow a moderate decline in public debt compared to GDP (130.3% in 2018)
  • There will be no protectionist escalation, but there will be a slowdown in world trade (from +4.6% in 2018% to +3.7% in 2020)
  • The US growth remains solid (+2.8% in 2018, +2.3% in 2019), driven by the fiscal stimulus, which will then tend to weaken. There are currently no clear signs of price pressures (see Prometeia Discussion Note n. 5) consistent with three 25bp rate increases by the Fed for the current year (Fed Funds at 2-2.25% at the end of 2018)
  • Solid global economic scenario, and revised upwards, in the short term (+3.7% in 2018), but slowing down in the medium term (+3.1% the average 2021-2025)
  • Olivier Blanchard, Senior Fellow at the Peterson Institute for International Economics, guest at the presentation of the Outlook, shares Prometeia's scenario: "Solid growth in the short term, I don't see global imbalances on the horizon. Geopolitical events possible source of uncertainty." 

Italy's long run-up

In 2017, Italian GDP grew by 1.5%, one of the best results of the last 15 years, and early signs indicate that 2018 will be a year in which growth will keep essentially at the same pace (1.4%). The international cycle able to sustain Italy’s growth at rates above potential, from now until 2020, will allow the indicators to continue to improve, but without the possibility of moving further ahead. The external conditions will in fact become less favorable, from monetary policy, which will progressively reduce its support, to fiscal policy, which is currently unknown but which will have to deal with the constraints on public debt. While assuming a slowdown in the deficit reduction path compared to the current targets and the constraints of the Fiscal compact, Prometeia’s baseline scenario is on the border of the (risky) excessive deficit procedure (EDP), although without crossing it. Moreover, the level of budget deficit would remain at an average of 1.5% of GDP, far from the high levels of the past. 

However, given the projected scenario, the path would allow a moderate decline in public debt relative to output, which is of primary importance for ensuring macroeconomic stability in the country. The slowdown in adjustment would allow room for additional expenditure of around €5 billion in 2019, which could lead either to a strengthening/extension of the inclusion income (REI) or to revenue-reducing measures (very partial compared to those announced). The improvement observed at the macroeconomic level does not seem to be in line with the perception of the majority of Italians


No trade war, but trade slowdown

With regards to world trade, Prometeia’s scenario does not include the possibility of a protectionist escalation which leads to a real trade war. Tariffs introduced so far are limited, the effects will be very different between countries and industries, while macroeconomic effects are, for the time being, negligible. If the protectionist measures were limited to steel and aluminum, the 71 "product codes" for which the law modifies the tariff profile are worth, for Italy, little more than 500 million Euros, equal to 1.2% of total Italian exports to the United States. The measures taken so far by the US are increasing tension, and the tones adopted by President Trump increase the risk of commercial retaliation. Even in the absence of a trade war, the slowdown of the main economies will lead to a slowdown in international trade.


Global expansion is solid, but increased risks from the US

While the path of monetary expansion is becoming clearer in the main industrialized countries, expansionary fiscal measures are being strengthened in the US, protectionist measures are being implemented and others are being threatened. The world's largest economy wants to reinvigorate its growth but wants to keep its expansionary effects limited to the domestic economy, minimizing those on the rest of the world. The rest of the world is experiencing a widespread recovery: the capital investment cycle is strengthening and is laying the foundations for stronger growth; employment is increasing; inflation remains contained and supports households' purchasing power. 

The risks come mainly from the United States and from the possibility of inflation picking up, which would not allow the Federal Reserve to maintain the caution it has held in increasing the policy rates so far. The budgetary measures adopted by the US Congress in February allow for additional expenditure of half a percentage point of GDP this year and two-tenths in 2019, which add to the expected expansionary effects of the tax reform approved last December. A support to demand that could encourage inflation to pick up, and feared by markets. However, there are currently no clear signs of price recovery. For these reasons, we believe that the Fed will increase the Fed Funds rate by 75 basis points in 2018, bringing it to between 2% and 2.25% at the end of the year.


Blanchard: “Strong global growth with no imbalances, risks from geopolitical events”

Olivier Blanchard, Senior Fellow at the Peterson Institute for International Economics, speaker at the presentation of Prometeia’s Quarterly Economic Outlook, agrees on Prometeia's macroeconomic scenario: "The baseline is reasonable, growth in advanced economies is robust and balanced. I do not see global imbalances being created that could 'kill' the recovery, either from a real or a financial point of view."

One of the main reasons for uncertainty, however, is the possible overheating of the American economy, whose risk, according to Blanchard, "is shifting upwards, even if there will not be a major increase in inflation". "The American economy has strong momentum - continues the former chief economist of the International Monetary Fund - and the Fed may need to intervene on rates more than anticipated so far."

The economist then downsizes the economic scope of Trump’s protectionist measures: "From a macroeconomic 'mechanical' point of view, a trade war 'limited' to certain products does not have a great effect in the 21st century". But it can create an environment of enormous uncertainty: “From now on geopolitics goes back to have a non-negligible impact on the underlying scenario.

Watch the full interview with Olivier Blanchard (video)