Global Growth Outlook 03/2019

March 2019 GLOBAL GROWTH OUTLOOK

Growth or recession?

Global economy at a crossroads

▪

Risk of global recession considerably higher. As things stand, one major bad decision would be enough to tip the balance and endanger Europe’s economic growth. Rising US interest rates and very flat yield curves, escalating trade tensions and a disorderly Brexit all have the potential to trigger a global recession.

▪

The federal government has no time to lose. It should offer investment incentives for climate protection and research and launch a tax reform.

Germany’s economic momentum has already suffered in the last few months from the global slowdown and one-off factors in industry.

▪

Even without any additional global economic risks, worldwide growth will flatten out to just over 3.25 percent in the current year. World trade is expected to increase by 3.5 percent, and global industrial production by just over three percent, with only marginal growth in industrialised countries.

▪

Europe has passed its cyclical peak and is set to grow by just 1.5 percent this year, the euro area by only 1.25 percent. Positive trends on the labour market and in consumption expenditure are offset by a slowdown in investment and net exports.

▪

We expect the U.S. economy to grow by 2.25 percent this year.

Domestic growth drivers are still robust but are gradually losing steam.

▪

China’s economic momentum is continuing to drop off. Growth of 6.25 percent will only be achieved if trade tensions do not escalate further.

Growth or recession? | Global economy at a crossroads 05/03/2019

Content Growth or recession: will 2019 mark a turning point? .................................................................... 3 Global economy continues to lose steam ........................................................................................ 6 Global industrial production loses pace ........................................................................................... 7 Advanced economies ............................................................................................................................ 8 U.S. industry records strong growth ...................................................................................................... 8 Industrial production in emerging economies ........................................................................................ 9 Momentum drops in Asia while Latin America enters its fifth year of recession ................................... 9 World trade........................................................................................................................................... 9 Foreign direct investment ................................................................................................................ 10 Macroeconomic policy ...................................................................................................................... 10 Financial markets and exchange rates ........................................................................................... 13 A mix of upwind and headwind for the U.S. economy .................................................................. 15 Budget dispute and shutdown: the danger still prevails ...................................................................... 16 U.S. labour market still booming ......................................................................................................... 17 China: clouds on the horizon but no storm.................................................................................... 17 Economic indicators paint a mixed picture .......................................................................................... 18 Stability, reforms and new growth impetus ......................................................................................... 19 Debt still a problem .............................................................................................................................. 19 Structural market economy reforms still lacking.................................................................................. 20 European economy past its peak .................................................................................................... 20 Economic slowdown in almost all economies ..................................................................................... 20 Whole euro area feels the downturn ................................................................................................... 21 Japan set to remain on course of moderate expansion ................................................................ 22 Regional outlook ............................................................................................................................... 23 Consequences for Germany ............................................................................................................... 24 Sources .............................................................................................................................................. 25

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Growth or recession? | Global economy at a crossroads 05/03/2019

Growth or recession: will 2019 mark a turning point?

Before providing a detailed analysis of global economic growth in the current year, we need to address the basic question of whether there is a substantial risk of a global recession. For this is indeed a risk we cannot simply ignore. The economic slowdown in conjunction with major political risks and an obvious global economy leadership problem are a toxic cocktail that could very quickly lead to a turnaround in sentiment and production worldwide. Turning points in economic development are generally very difficult to identify using early indicators. Governments and the business community must however face the fact that this risk has grown considerably in the last year. The threat of a recession must be considered notable especially for the second half of 2019 and for 2020 and particularly for the United States and Europe. Market doubts about the competence of the governments of many major economies should be regarded as a crisis factor in themselves. The markets certainly do not present a picture of confidence.

The outlook for economic development this year is by no means unanimous. Governments, central banks and enterprises are all struggling to reliably assess the many risks facing the global economy.

On the international stock markets in particular, this led to a hefty adjustment in the fourth quarter of last year, followed by a substantial recovery in January. High volatility is not unusual during the latecycle phase. Periods in which the United States hikes its interest rates are generally characterised by a high degree of uncertainty due to the major impact of the Fed on the global stock and bond markets and real economic development. The U.S. yield curves, which have flattened out considerably, are now additionally unsettling the bond markets. Unlike corrections on the stock markets, inverse yield curves and approximations of market conditions to these curves are a much more accurate indicator of recession.

Main forecast: Growth of real gross domestic product compared to previous year Global economy

3¼

Euro area

1¼

World trade

3½

EU

1½

USA

2¼

Germany

1½

China

6¼

Japan

1

Source: BDI

Latent international trade and security disputes, sluggish global trade, rising key interest rates, the risk posed by Brexit, uncertainties on the government bond markets in Italy, emerging countries in crisis and the slowdown in China have been squeezing corporate profits worldwide. A whole series of hard facts and sentiment indicators all fell sharply following record levels in spring and summer 2018. The onslaught of negative news, while not completely at an end, has brightened into a slightly more mixed picture at the beginning of 2019 with recent price gains on the stock markets.

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Growth or recession? | Global economy at a crossroads 05/03/2019

Business climate indicators*, OECD 102

101

100

99 2017 Business Tendency Surveys (Manufacturing)

2018 Consumer Opinion Surveys

Leading Indicator

*seasonally adjustedt (Index=100) Source: Macrobond

As the global economic upturn is now in its tenth year and cycles have rarely lasted that long, the general nervousness is both founded and tangible. Furthermore, the unusual and inappropriate macroeconomic policy mix of the Trump administration and the Fed mean that the uncertainty on the further course of the U.S. monetary and fiscal policy is even higher than usual for a late-cycle phase. The fiscal policy of the U.S. administration and Congress risks turning the expansionary momentum of 2018 and 2019 that was unleashed by increased federal expenditure and loan-financed tax cuts into a slightly contractive policy as of 2020. This foreseeable slowdown in U.S. growth will thus coincide with an already cooling Chinese and European economy. If the protectionist screws in international trade policy are further tightened by new measures from the United States against the People’s Republic of China and the European Union and this prompts the corresponding countermeasures, this, together with a hard Brexit, would all combine to produce a toxic cocktail for a sure-fire recession. The loss of growth these measures would trigger would be very visible and considerable in the short-term of the next two to three years. A drop in sentiment would then be enough to turn a marked slowdown into a hard negative response on the financial markets and the enterprises of the real economy. Global consumer trends have also proven less robust than expected from the labour market and income indicators due to the deluge of bad news in 2018.

An additional factor adding to the uncertainty is that, on account of the anaemic recovery and continuing high-volume macroeconomic, particularly monetary, measures implemented to bolster this recovery, the major economies would really need another five years to ease their monetary and fiscal policy back to normal. A recession before this point in time would be particularly ill-timed as the reserves available, particularly to central banks, to ward off risks are far below those of previous cycles. This would leave the central banks of the United States and the euro area without much scope for action, which, for the United States, would normally involve interest rate cuts of five hundred basis points (Summers 2019).

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Growth or recession? | Global economy at a crossroads 05/03/2019

Baltic Dry Index* 1800 1600 1400 1200 1000 800 600 400 200

*Index for shipping freight Source: Macrobond

In this event, the governments, which are currently still working on a moderate consolidation of their public budgets, would be required to make an international effort to sustain global demand through fiscal incentives to stimulate investment and private consumption, even if their debt levels have not yet been pegged down sufficiently. Dealing with such a situation would require extensive international collaboration such as was seen after the major financial crisis of 2008/09, but as no one currently believes this could be repeated, the financial markets are responding to risks (and the fact that these may not be adequately cushioned) with all the more uncertainty. This means that the economic policy decisions to be taken in the next few weeks, above all in London and Washington, though in themselves unrelated, will be decisive in determining whether the global economy is heading for its second Anglo-Saxon-induced global recession within the space of a decade or whether the world will be spared this fate. If the biggest risks do not materialise in 2019, the global economy should continue to grow, though at a slower pace than last year.

World: Industrial production* emerging economies Schwellenländer advanced economies entwickelte Volkswirtschaften

5 4 3 2 1 0 -1 2016

2017

2018

*Production index: two-month average, after calendar and seasonal adjustments, in percent, year on year Sources: Macrobond, Netherlands Bureau for Economic Policy Analysis, own calculations

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Growth or recession? | Global economy at a crossroads 05/03/2019

Global economy continues to lose steam In terms of economic development, the year 2018 did not play out as expected at the beginning of the year. The global economy had hardly regained its footing when it started faltering again in spring.

Global economic growth is estimated to have grown 3.7 percent instead of four percent in real terms.

The International Monetary Fund expects growth to be slightly slower still this year at 3.5 percent, provided that none of the major risks materialise (IMF 2019). This would put global economic growth below its long-term pre-crisis average growth of four percent. Considering that this prediction includes a high forecast for the United States, which is unlikely to be met due to the government shut-down, and the technical assumption that a hard Brexit will be avoided, this figure may well still be too optimistic. We should be glad if the year rounds off with 3.25 percent growth for the world economy.

Forecast summary: Growth in real GDP 2018/19/20 in percent 2018

2019

2020

IMF1

OECD2

EUCOM3

IMF1

OECD2

EUCOM3

IMF1

World

3.7

3.74

3.7

3.5

3.54

3.5

3.6

3.54

3.5

USA

2.9

2.9

2.9

2.5

2.7

2.6

1.8

2.1

1.9

China

6.6

6.6

6.6

6.2

6.3

6.2

6.2

6.0

5.9

Japan

0.9

0.9

1.1

1.1

1.0

1.0

0.5

0.7

0.5

EU

1.9*

OECD2

1.5*

EUCOM3

1.7*

Euro area

1.8

1.9

1.9*

1.6

1.8

1.3*

1.7

1.6

1.6*

Germany

1.5

1.6

1.5*

1.3

1.6

1.1*

1.6

1.4

1.7*

France

1.5

1.6

1.5*

1.5

1.6

1.3*

1.6

1.5

1.5*

Italy

1.0

1.0

1.0*

0.6

0.9

0.2*

0.9

0.9

0.8*

Spain

2.5

2.6

2.5*

2.2

2.2

2.1*

1.9

1.9

1.9*

U. Kingdom

1.4

1.3

1.4*

1.5

1.4

1.3*

1.6

1.1

1.3*

India

7.35

7.5

7.4

7.55

7.3

7.5

7.75

7.4

7.5

Brazil

1.3

1.2

1.1

2.5

2.1

1.9

2.2

2.4

2.3

Russia

1.7

1.6

1.7

1.6

1.5

1.6

1.7

1.8

1.8

1: IMF (January 2019) 2: OECD (November 2018) 3: European Commission (November 2018; *February 2019) 4: Forecast on basis of 70 percent world GDP (PPP of 2013) 5: Information on India for the fiscal year in current prices

The slowdown is likely to hit industrialised countries harder than emerging countries and is set to continue into 2020 (around one quarter of a percentage point less each year for industrialised countries;

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Growth or recession? | Global economy at a crossroads 05/03/2019

the IMF is only predicting growth of two percent for 2019). The major factor likely to keep growth down is the slowdown in the United States as well as the lower momentum forecast for Germany, Italy and the United Kingdom. The main drivers of growth have weakened considerably and are set to flag still further this year. The United Kingdom is growing significantly under potential due to Brexit. Turkey, meanwhile, got into deep water last year and is likely to undergo a recession in 2019. This year will also see fiscal stimulation in the United States come to an end. China has been undergoing an industrial slowdown for one year now, triggered by the government’s wish to get a handle on excessive lending and grant special privileges to state-owned companies. The former is curbing the property market and manufacturing output, while the latter is keeping growth momentum down due to higher inefficiency (Lardy 2019).

Global trade also continued to lose considerable momentum in 2018, rising four percent overall in real terms. This year, growth in global trade is unlikely to reach more than 3.5 percent, meaning it will fall back below its long-term average. Developments in the last few weeks and leading indicators are all pointing towards an even more pronounced slowdown, with not only economic indicators of production and global trade but also the prospects of companies all pointing down. Purchasing manager indexes have dropped worldwide but are largely still in growth territory. Industrial output was weak in the fourth quarter, above all in capital goods. China, the largest market worldwide for industrial products, nonetheless still recorded 6.2 percent growth in industrial production.

Retail sales, meanwhile, which have been robust for several years have lost momentum around the world. The expectations of businesses and consumers regarding future developments have dropped considerably. This was compounded by several factors causing bottlenecks on the supply side including the shortage of workers in the late-phase cycle in the United States, in the majority of European countries, and with first signs of this problem emerging in Asia. Already in the fourth quarter 2018 these developments led to substantial earnings revisions, first in technology stocks and later across most stock markets. Overall, 2018 turned out to be a very difficult year for financial investors, with doubledigit plunges in the Chinese and German stock markets, and most other markets in negative territory.

Yields have not improved on the bonds markets either, except in the United States. Risk premiums for more high-risk segments of corporate financing did increase however, particularly in the United States.

Yields on bond markets actually dropped in many markets on account of the weaker growth prospects, including in Germany, but also in the United States and the United Kingdom. Risk premiums were higher particularly for Italian government bonds and affected bank bonds. The spread compared to federal government bonds was, in part, over 300 basis points, but then swiftly fell below this mark following an agreement between Rome and the European Union on the Italian budget. Only the oil markets have reached a certain degree of price stability, settling at around 55 US dollars per barrel which could be maintained for several years according to the surveyed market expectations. Prices for metals and agricultural products also suffered single-digit drops.

Global industrial production loses pace Global industrial production lost considerable momentum in course of the year. According to data from the Netherlands Bureau for Economic Policy Analysis (CPB), growth in production dropped in comparison to the prior-year period from 3.9 percent in the first quarter to 2.8 percent in the third quarter 2018. The quarterly growth rate, according to preliminary figures, dropped to just over two percent in the last quarter of the year bringing the annual rate of production growth down to only three percent.

Although growth was well below the robust level of 3.5 percent recorded the previous year, it was still above the average rate of the last ten years.

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Growth or recession? | Global economy at a crossroads 05/03/2019

In the emerging countries, production in the first quarter 2018 expanded at a rate last seen in 2012, going up 4.4 percent year on year. In advanced economies, though, production growth began to lose strength from the very beginning of 2018. The rate of growth declined throughout the further course of the year in both groups of countries. Thanks to robust growth in the first half of the year, industrial production in the advanced economies still managed to grow above the long-term average. Growth in the emerging countries, with a 3.5 percent increase in production, stayed at the average level of the last three years.

The global purchasing managers’ index for manufacturing (PMI) does not indicate a contraction so far.

In January 2019, the PMI dropped for the ninth time in a row reaching its lowest level since September 2016. At 51.4 index points, the PMI is, however, still pointing towards further growth.

Advanced economies U.S. industry records strong growth Advanced economies: Industrial production*

other advanced economies restliche entw. Volkswirtschaften Euro area Euroraum Japan USA

5 4 3 2 1 0 -1 -2 2014

2015

2016

2017

2018

*Production index: two-month average, after calendar and seasonal adjustments, in percent, year on year Sources: Macrobond, Netherlands Bureau for Economic Policy Analysis (CPB)

In 2018, the U.S. industry accounted for slightly more than half of the increase in industrial production in the advanced economies overall although its share of production is only slightly more than one third. The production increase of 3.9 percent is likely to be the strongest result since 2010.

Japanese industry had a hard time maintaining last year’s growth rate. Following an increase in production of 2.5 percent in the first quarter 2018, the rate of expansion dropped off considerably. At the start of the second half year, production stagnated and even dipped into negative territory towards the end of the year. In the euro area, the downward trend was even more pronounced. While production increased by more than three percent in the first quarter 2018 year on year, growth slowed down markedly in the further course of the year. In the fourth quarter, output is likely to have been two percent below the previous year’s level. An overall annual result of plus 1.1 percent is expected for both regions.

In the remaining advanced economies, industry got off to a good start in the first quarter with an increase of over four percent. As the year progressed, the pace of production decreased significantly.

Industrial production is still believed to have grown above average in 2018 overall with an increase of 2.6 percent.

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Growth or recession? | Global economy at a crossroads 05/03/2019

Industrial production in emerging economies Momentum drops in Asia while Latin America enters its fifth year of recession Among the emerging countries, it is the Asian countries, and particularly China, that are generating expansion in industrial production. However, these powerhouses of growth flagged somewhat during 2018. Following a rise of six percent in the first quarter 2018, the rate of growth dropped in the further course of the year to 4.6 percent in the fourth quarter. Compared to the previous year, industrial production is like to have increased by only 5.3 percent for this group of countries. This would be the lowest growth seen since 2015. The industrial sector in Africa and the Middle East performed well, stepping up production for the fifth year in a row with an increase of 1.2 percent in 2018. In the countries of Eastern and Central Europe, preliminary figures put growth at 2.9 percent, which matches that of the previous year. These regions thus contributed 0.2 percentage points each to the growth of production in emerging countries. Developments in Latin America, on the other hand, are worrying. Industrial production here dropped for the fifth year in a row, this time by 2.5 percent and thus the second-largest drop of the last five years. The group of emerging countries overall recorded a growth loss of 0.4 percentage points.

Emerging economies: Industrial production* Africa/Middle East Afrika/Mittlerer Osten Latin America Lateinamerika Zentralund Eastern Osteuropa Central and Europe Asien Asia

5 4 3 2 1 0 -1 2014

2015

2016

2017

2018

*Production index: two-month average, after calendar and seasonal adjustments, in percent, year on year Sources: Macrobond, Netherlands Bureau for Economic Policy Analysis (CPB)

World trade According to International Monetary Fund estimates from January, world trade last year increased by four percent over the previous year. Preliminary figures from the Netherlands Bureau for Economic Policy suggest that in the final quarter of 2018 world trade only increased by a moderate 1.3 percent over the previous quarter. The weak growth at the end of the year could already be due to the rise in protectionism around the world. Fourth quarter growth was almost exclusively generated by the demand for imports by emerging countries. The emerging countries have also been the ones benefitting from this demand with exports increasing by 3.1 percent while industrialised countries saw exports fall

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Growth or recession? | Global economy at a crossroads 05/03/2019

(down 0.4 percent). The RWI/ISL Container Throughput Index, which measures the volume of global trade based on the capacity utilisation of key container ports around the world, increased in December 2018 to 135.3 index points. The still robust capacity utilisation of containers according to RWI/ISL could also be attributed to the fact that the car trade is not included in this indicator.

RWI Container Index 150

140

140 130

130

120 110

120

100 90

110 2014

2015

2016

2017

2018

RWI/ISL Container Index RWI/ISL Container Index, Trend RWI/ISL Container Index, seasonally adjusted (right axis) Source: Macrobond

Foreign direct investment In January, UNCTAD reported a clear decrease of 19 percent in worldwide investment flows compared to the previous year (down to 1.2 trillion U.S. dollars in 2018). This third consecutive annual drop has brought global FDI movements down to the level seen before the global financial crisis. The industrialised countries were particularly affected by the slump in 2018, experiencing a decrease in investment of as much as 40 percent. Investment flows to Europe were most strongly affected, with a huge 73 percent decrease, while North America only had to deal with a drop of around 13 percent. The cause of this discrepancy is the new tax legislation in the United States that has triggered the repatriation of investment from other industrialised countries. Investment in emerging countries went against the global trend and grew three percent in 2018 and now lies at 58 percent of global annual FDI flows. After a staggering decline in 2017 of 90 percent compared to 2016, investment in the United Kingdom recovered somewhat in 2018 and increased by 20 percent over the weak previous year. UNCTAD is expecting global investment flows to rise this year, partly due to a slowdown in the repatriation of U.S. foreign investment.

Macroeconomic policy The international organisations expect the course of fiscal policy in the major economies to remain slightly expansionary in 2019. In the United States, fiscal policy will still be stimulating the economy by well over half a percentage point this year, and, in Germany, as much as one percentage point of

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Growth or recession? | Global economy at a crossroads 05/03/2019

GDP. Budgets in Italy and France have also moved away from their stringent course of consolidation.

China and Korea are expected to set slight expansionary stimuli in the course of the year. The government in Japan plans to cushion roughly half of the VAT hike scheduled for November with fiscal spending programmes.

In Europe, meanwhile, most countries have made progress in consolidating their budgets in a positive environment of strong growth and low interest rates. Net borrowing in particular has gone down.

Government expenditure compared to GDP has dropped 2.5 percentage points since 2014, standing at 46.6 percent at last count (second quarter 2018), and thus dropping much more than the state revenue ratio, which only sank marginally by 0.6 percentage points to 46.1 percent. The debt ratios of many countries are still very high although low interest rates and longer average terms should ease the burden somewhat for the large majority of OECD countries in the medium term (OECD 2018). The average debt of euro area countries has dropped from 92 percent in 2014 to 86 percent according to the latest figures. Germany is like to gradually reduce surpluses following several years of substantial budget surpluses and a steadily falling general government debt ratio. The fiscal policy in the United States and Japan, on the other hand, has fallen far short of consolidation requirements. In the People’s Republic of China, the fiscal position of the government is likely to deteriorate slightly due to the planned fiscal policy stimuli and markedly lower medium-term growth prospects.

Many countries across the world would indeed have the fiscal policy space required to provisionally increase net borrowing in the event of a recession, although in the United States, Japan, Italy, and on a smaller scale, France and the United Kingdom this would create consolidation problems in the medium term. Countries that are currently still pursuing an expansionary fiscal policy are hardly using the leeway they have to strengthen growth potential by encouraging inclusive growth through measures geared towards productivity, innovation and labour market participation, for example, but are instead using it for transfer payments to certain target groups with no visibly logical distribution policy.

In terms of monetary policy, most of the globe remains on a moderately expansionary course. The Federal Reserve last raised its key interest rate on 19 December to a range of 2.25 to 2.5 percent and had two surprises in store for the markets on 30 January: First, that further interest rate hikes would only make sense if the data changed, as due to economic headwinds from some quarters it saw no cause for an increase at this point. Second, that it would be more flexible with its balance sheet runoff programme in future and not maintain its policy of a reduction of around 50 billion US dollars per month.

It also added that the debate within the Fed on the precise target volume and timeline of the reduction had not yet been completed and that the liquidity supply requirements for the U.S. economy were higher than previously anticipated. The official Fed statement talks about patience regarding further interest rate hikes: “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.� (Fed 2019). Both points took the markets very much by surprise as changes in the course of Fed policy are usually communicated less abruptly. It is not known whether the majority of decision-makers are currently still advocating further interest rate hikes in the course of the year. As recently as September, the monetary policy decision-makers had signalised another two interest rate hikes for 2019 (average value of the forecasts of the members of the Federal Open Market Committee), although they had reduced their expectations regarding the interest rate level at the end of the hike cycle. If at all, the Fed is only likely to hike interest

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Growth or recession? | Global economy at a crossroads 05/03/2019

rates in the second half of the year. The cost pressure of wage increases in a very tight labour market will, in any case, remain tangible and keep the core inflation rate up.

Key interest rates in selected countries 3

2

1

0

-1

Europäische Zentralbank European Central Bank

Federal Reserve Bank

Bank of England

Bank of Japan

Source: Macrobond

The People’s Bank of China, the Chinese central bank, recently curbed the growth rate of bank lending to counteract risks to financial stability. This considerably muted industrial activity and the property markets in the course of last year. Monetary policy has now become slightly expansionary again to fend off too sharp a slowdown, particularly on the property market. The People’s Bank of China significantly cut commercial banks’ reserve requirements in January (down to 12.5 percent from 23 January) and is expected to maintain this course throughout the year. It has also taken additional measures to substantially increase liquidity, injecting well over half a trillion RMB in open-market operations. The key interest rate, on the other hand, is likely to be kept steady. Capital market yields here are slightly above the U.S. level and should provide for a relatively stable development of the renminbi-dollar exchange rate. The possible escalation of trade tensions with the United States, and even more so, weak domestic demand, are likely to trigger higher state expenditure and further tax cuts in addition to the tax relief for individuals that came into effect at the beginning of the year.

The European Central Bank maintained its monetary policy strategy at the beginning of the year, despite considerably weaker economic data in the euro area, the revision of growth forecasts in December, and increasing risks to economic development from the international environment. It also indicated that if the economy slows down further, the measures related to the refinancing of banks could represent a channel for adjustment. There was no mention of a change to its purchasing programmes or interest rate policy. On account of recent developments, most players on the financial markets are not expecting the key interest rate to be increased this year. In a press conference in January, ECB President Draghi referred to the sluggish development of prices and lending but underlined the need to clearly differentiate between temporary disturbances, such as occurred with new car registrations or trade policy shocks, from the robust expansionary trends in the growth components of the domestic economy. The ECB will probably only analyse the situation again in March or April before communicating any further course of action. The ECB is still in a challenging position

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Growth or recession? | Global economy at a crossroads 05/03/2019

given the markedly gloomier growth prospects and expected weakening of inflation in the course of the year.

The Japanese central bank is currently sticking to its monetary policy strategy. In addition to maintaining a negative interest rate for savings, the Bank of Japan will be buying stocks to the volume of around 80 trillion yen in the course of the year and is intending to keep the yields of ten-year bonds to zero percent by purchasing Japanese government bonds. The government plans to reach its target inflation rate of around two percent with quantitative and qualitative easing in conjunction with yield curve control.

Financial markets and exchange rates So far, the heightened international risks have only impacted individual segments of the financial markets. Among those particularly affected are the stock markets and individual currency markets. A close eye should be kept on the international bond markets. In the United States, yields for ten-year government bonds pointed upwards in the course of the year 2018 but in the fourth quarter dropped well below the three-percent mark again (2.66 percent at the end of January). In conjunction with rising interest rates, this has increasingly flattened out the yield curves. The spread, as measured by the yield difference between ten and one-year U.S. Treasuries, dropped from an already low level of 1.66 percent in 2015 to 30 basis points at last count. As inverse yield curves are an early warning sign of recession, the US monetary policymakers will be sure to watch these very closely. In the euro area, the same indicator dropped to just over one percent, but it has in fact been fluctuating between 1.26 and 1.06 percent since 2015. In Germany, ten-year yields for Bunds dropped once again. In early 2018 they had almost reached the one-percent mark before dropping back to under 0.5 percent in the further course of the year, down to just over 0.1 percent at last count. The Italian yields followed a positive trend in the course of the year on account of the uncertainty surrounding the financial policy of the Conte government, but decreased again once agreement had been reached between Rome and Brussels towards the end of the year. In the United Kingdom, yields had most recently risen to just over one percent with the spread dropping to only just over fifty basis points. Japan is a special case as its central bank is controlling the yield curves by keeping the interest rate and ten-year yields at zero.

The risk premiums on bonds in the emerging countries of Asia and Latin America increased by a good fifty basis points in 2018, and around 75 basis points in Europe, mainly because of Turkey (OECD 2018: 31).1 Apart from Argentina and Turkey, this trend is above all a reflection of the Fed’s monetary policy. Increasing interest rates in the United States lead to an outflow of assets in emerging countries, putting downward pressure on the currencies of these countries.

1

Measured here as the yield difference between dollar-denominated government bonds of emerging countries to US government bonds of the same term according to the JP Morgan Emerging Markets Bond Index.

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Growth or recession? | Global economy at a crossroads 05/03/2019

Bond yields* 5 4 3 2 1 0 -1 Jan 2016

Jul 2016

Germany

Jan 2017

France

Italy

Jul 2017 Spain

Jan 2018 U. Kingdom

Jul 2018 USA

China

Jan 19 Japan

*Yields of ten-year government bonds Source: Macrobond

The growing risk aversion on financial markets has caused premiums on corporate bonds for financial stocks and real economy enterprises to rise considerably, going up a good fifty and forty basis points respectively in the course of the year.

Trade-adjusted exchange rates of the US dollar and the euro 140 130 120 110 100 90 80 2017 Euro, Wechselkurs, Euro, nominal nominal effektiver effective exchange rate breiter index, Index broad Euro, real real effektiver effective exchange rate breiter index, Index broad Euro, Wechselkurs,

2018 US-Dollar, Wechselkurs, Index U.S. dollar nominal effektiver effective exchange rate breiter index, broad U.S. dollar,real realeffektiver effective Wechselkurs, exchange ratebreiter index, Index broad US-Dollar,

*Index: 2015=100 Sources: Macrobond, BIS

The world’s major stock markets got off to a positive start in 2018 initially, but then saw a very rough end to the year. Shanghai recorded the biggest losses, going down 19 percent between the beginning of January 2018 and the end of January 2019, closely followed by Hong Kong’s Han Sen which dropped 17 percent. The Nikkei fell by 14 percent and the DAX by twelve percent. The U.S. markets

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Growth or recession? | Global economy at a crossroads 05/03/2019

lost less, with the Dow Jones decreasing by a good eight percent, the S&P 500 by a good five percent and the NASDAQ by three percent. The EuroStoxx50, on the other hand, held its ground.

On the foreign exchange markets, the Argentinian peso and the Turkish lira suffered drastic losses.

The peso exchange rate to the dollar dropped from 18 to 37, while the Turkish lira declined from 3.7 to 5.2 lira per dollar most recently and from 4.5 to six liras per euro. The two currencies have just made a slight correction in the last few weeks. The Russian rouble also depreciated by more than ten percent.

The U.S. dollar appreciated by eleven percent on a nominal and trade-adjusted basis and by twelve percent in real terms. This reflects the country’s expansionary fiscal policy in combination with rising interest rates and capital market yields. The transatlantic difference in yields between capital market interest rates in the United States and in Europe and Japan has now grown to over two hundred basis points.

The external value of the euro appreciated in the course of 2018 by around three percent in nominal terms and only two percent in real terms. In the bilateral exchange rates, on the other hand, the euro lost five percent against the dollar and three percent against the yen. The appreciation of the euro of 30 percent against the Turkish lira, 15 percent against the Brazilian real and seven to eight percent against the Russian rouble and the Indonesian rupee reflects the weakness of these currencies.

Exchange rates against the U.S. dollar

1,30 1.30

0,85 0.85

120

1,25 1.25

0,80 0.80

115

0,75 0.75

110

0,70 0.70

105

1.05 1,05

0,65 0.65

100

1.00 1,00

0.60 0,60

95

1,20 1.20

7,1 7.1 7,0 7.0 6,9 6.9 6,8 6.8 6.7 6,7 6.6 6,6 6.5 6,5 6.4 6,4 6.3 6,3 6.2 6,2

1,15 1.15 1.10 1,10

1.00 Euro Achse) Euro (linke (left axis) Pfund Achse) PoundSterling Sterling(rechte (right axis)

Renminbi (rechte (right axis) Renminbi Achse) Yen Achse) Yen (linke (left axis)

Source: Macrobond

A mix of upwind and headwind for the U.S. economy According to IMF, OECD and European Commission estimates, the U.S. economy grew by around 2.9 percent last year. The upswing of the U.S. economy was thus more pronounced in 2018 than in 2017, which saw GDP growth of 2.2 percent. Last year’s positive trend was fuelled largely by the impacts of the U.S. tax reform and increased oil prices. According to figures from the Bureau of Economic Analysis (BEA), the U.S. economy grew by an annualised 2.2 percent in the first quarter 2018, before surging up 4.2 percent in the second quarter. Growth was also stronger than expected in the third quarter,

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Growth or recession? | Global economy at a crossroads 05/03/2019

going up by 3.4 percent. Private consumption expenditure, plant and equipment investment and public expenditure all contributed to growth in the third quarter.

Exports gained considerable momentum in the first half of the year, with a spike in exports in the second quarter (from 3.6 percent in the first to 9.3 percent in the second quarter, both compared to the previous quarter). Exports then fell by 4.9 percent in the third quarter of 2018 compared to the previous quarter. Imports also increased by three percent in the first quarter, quarter on quarter, but then dropped by 0.6 percent in the second quarter before rising 9.3 percent in the third quarter. The tangible decrease of U.S. exports in conjunction with an increase of imports in the third quarter occurred at the same time as additional import tariffs between the United States and China were imposed (BEA, 2018a; BEA, 2018b). Currently, 250 billion U.S. dollars’ worth of U.S. imports from China and around 110 billion dollars’ worth of U.S. exports to China are affected by the additional tariffs (as of February 2019).

Because of the U.S. government shutdown, no official GDP data is currently available for the fourth quarter of 2018. The Congressional Budget Office (CBO) and the Federal Reserve estimate real GDP growth of 3.1 percent for 2018. The Fed and the CBO both expect a slowdown in economic output in 2019, predicting GDP growth of 2.3 percent (CBO 2019a). The OECD and the IMF forecast U.S. economic growth of between 2.5 and 2.7 percent of GDP in 2019. This is likely too optimistic given the latest available data. The global slowdown will also affect the U.S. economy. We expect growth to reach 2.25 percent.

The macroeconomic effects of the tax reform from 2017 and 2018 will continue to be felt in the current year, although they will eventually level out. The fiscal stimulus has so far tangibly boosted imports by strengthening domestic consumption. However, the tax reform comes with negative effects, including the decrease of tax revenue and a substantial budget deficit, which the OECD has estimated at 6.6 percent of GDP for 2018 and 6.9 percent of GDP for 2019.

Budget dispute and shutdown: the danger still prevails The U.S. federal budget consists of three types of expenditure: around 65 percent flows into mandatory spending, which is determined by multi-annual programmes enacted by law. Seven percent goes into servicing debt. The remaining approximately 30 percent of expenditure is approved in the annual budget bills. This discretionary spending is coordinated every year in twelve appropriation bills, the most important of which are packaged into an omnibus spending bill. The current U.S. budget dispute centers around the use of this discretionary spending. Federal authorities shut down if Congress and the President do not reach an agreement.

Although the U.S. fiscal year begins in October, Congress had only approved five of the twelve appropriation bills for the 2019 budget year required by 1 October 2018, accounting for three-quarters of the discretionary spending budget. The authorities whose financing had not yet been conclusively secured were able to keep working until 21 December thanks to a continuing resolutions. Continuing resolutions are used by Congress to fund the activities of the federal government for a limited period of time, generally with the same level of financing as the previous year. The last time that an entire budget process was completed punctually was in fiscal year 1997 (Committee for a Responsible Budget 2019).

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Growth or recession? | Global economy at a crossroads 05/03/2019

After the continuing resolutions expired on 21 December, the longest shutdown in the history of the United States commenced, lasting from 22 December 2018 to 25 January 2019. It was the second shutdown during the term of President Trump. On 25 January 2019, Trump and Congress agreed to approve the budget through the “Further Additional Continuing Appropriations Act” until 15 February 2019. The compromise did not include the funds demanded by Trump to build a wall on the border to Mexico, amounting to the sum of 5.7 billion U.S. dollars. Consequently, President Trump declared a state of national emergency on 15 February 2019 to circumvent Congress. The danger of a renewed budget dispute culminating in another government shutdown for the budget year 2019 has not yet been eliminated.

Estimates by the Congressional Budget Office (CBO) confirm that the most recent shutdown negatively impaired GDP growth in the United States. The costs to the real economy of the shutdown are estimated at three billion U.S. dollars for 2018 and another eight billion U.S. dollars for the first quarter of 2019. This amounts to a loss of GDP growth of 0.1 percent in the fourth quarter 2018 and 0.2 percent for the first quarter 2019. The CBO predicts that three of these eleven billion U.S. dollars will not be recovered following the end of the shutdown (CBO 2019b).

U.S. labour market still booming The positive trend on the labour market in 2017 continued through 2018. Unemployment kept falling in 2018, levelling out at a rate of around four percent. The U.S. labour market is thus close to full employment. The number of long-term unemployed – classified as individuals who have been unemployed for at least 27 weeks – was down to 1.26 million in November 2018, the lowest rate seen since 2007, the year before the crisis. In January 2019, the number of long-term unemployed dropped even further, going down to 1.25 million. In December 2018, the proportion of the unemployed who were long-term unemployed stood at 20.5 percent. The average period of unemployment was 21.8 weeks, down from 23.6 weeks in December 2017.

The robust growth in jobs and demographic pressure is slowly becoming noticeable in a shortage of labour. The labour market participation rate, or the proportion of the population that has a job or is actively seeking work, was at 63.1 percent in December 2018. In contrast to the rate of unemployment, which has been decreasing steadily for the last years, the participation rate has remained relatively stable at well below pre-crisis levels of around 66 percent (2007). These figures indicate that a section of the population has withdrawn from the labour market and does not benefit from the current upturn.

China: clouds on the horizon but no storm On the whole, China’s economy had a relatively strong year 2018 with growth of 6.6 percent. In the fourth quarter, however, the increase had dropped to only 6.4 percent over the previous year, indicating a further slowdown in economic momentum. This was the first quarter in which growth dropped below the politically significant level of 6.5 percent. Beijing’s economic planners had until now defined a growth corridor of between 6.5 and seven percent. The primary industry grew by 3.5 percent in 2018 overall, the industrial sector by 5.8 percent and the service sector by 7.6 percent. Alongside growth, Beijing is focusing mainly on structural changes on the labour market, municipal and corporate debt, and liquidity on the financial markets.

China has already taken monetary and fiscal measures to stabilise the economy but these interventions were relatively moderate compared to those of 2015. A further slowdown is expected for 2019,

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Growth or recession? | Global economy at a crossroads 05/03/2019

with problems on the domestic front compounded by lower global growth. The government and the central bank are likely to take measures already in spring to keep economic growth on course. We expect growth of 6.25 percent for the year overall compared to the previous year. This figure could go up to as much as 6.5 percent if China and the United States resolve the continuing trade disputes in the first half of the year. Should the trade protectionist measures escalate further, growth could drop to under six percent unless the government responds with much higher countermeasures to stimulate domestic demand.

Economic indicators paint a mixed picture Several factors are currently putting the brakes on the Chinese economy. These include the uncertainty created by the ongoing trade dispute and the resulting shifts in foreign investment and foreign trade, the faltering Chinese renminbi compared to the US dollar and the global slowdown. Additional factors playing negatively into the equation are mostly cyclical and structural components on the domestic market that have become known as the “new normal”.

Industrial production – defined here as companies with sales of more than 20 million CNY per year – lost some steam in 2018 but remained stable at 6.2 percent growth. Within this group, the high-tech sector, which receives special support from the Made in China 2025 initiative, did particularly well with 11.7 percent growth. Services expanded by 7.7 percent, thus continuing on their strong path, especially in information transfer, software and leasing.

Retail sales remained relatively robust, going up by nine percent. Online sales were particularly buoyant, surging up 25.4 percent. These results are in line with China’s target of strengthening domestic demand. Individual sectors suffered painful drops though. In the second quarter 2018, vehicle sales, which make up more than ten percent of GDP, decreased steeply. Sales of passenger cars dropped by six percent in 2018 overall.

Investment in tangible fixed assets increased by 5.9 percent. The proportion of private investment continued to gather momentum, rising by 8.7 percent. Investment in high-technology production grew by an impressive 16.1 percent. Investment in the property market still recorded growth of 9.5 percent in 2018 but the government already imposed restrictions some time ago to protect the market from overheating.

Foreign trade increased by 9.7 percent in 2018, surpassing the 30 trillion renminbi mark for the first time. Exports grew by 7.1 percent and imports by 12.9 percent, reducing the trade surplus by 18.3 percent. Most exports, 58.8 percent, were electronic and mechanical products. While the EU, the United States and the ASEAN countries are still China’s most important trading partners, trade along the Belt and Road grew by 13.3 percent.

On an annualised basis, consumer prices (CPI) increased by 2.1 percent and producer prices (PPI) by 3.5 percent. The rate of unemployment in urban areas was at 4.9 percent in December, and thus slightly lower than the previous year. The average monthly income of migrant workers grew by 6.8 percent year on year. The average disposable income increased by 8.7 percent in nominal terms and 6.5 percent in real terms, with per capita consumption increasing by 8.4 percent in nominal terms and 6.2 percent in real terms.

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Growth or recession? | Global economy at a crossroads 05/03/2019

The Caixin/Markit manufacturing purchasing managers’ index (PMI) came in at 48.3 points in January, thus once again dropping lower than the previous month and remaining below the critical mark of 50 points that indicates the threshold between economic expansion and contraction. The official NBS purchasing managers’ index recorded a value of 49.5 points for the same month, thus also still just within contraction territory. The Caixin services purchasing managers’ index dipped to 53.6 points in January but is still well within expansionary territory. The subgroups “export business” and “new orders” pointed up. The resilience of the service sector, which now accounts for more than half of China’s GDP is, for now, compensating for the slowdown in production growth. The official NBS purchasing managers’ index for this sector was even higher, at 54.7 points.

Stability, reforms and new growth impetus While concerns that the “new normal” would lead to a hard landing have largely subsided, new factors causing uncertainty have now emerged, namely the trade dispute with the United State and a weakening global economy. In the last few years, the government has mainly relied on infrastructure stimuli to boost the economy, but now it is setting its hopes on domestic demand and the Belt and Road Initiative to fuel growth. At the end of last year, the National Development and Reform Committee (NDRC) nonetheless approved 16 major infrastructure projects at its Central Economic Conference (CEWC) with a volume of 163.2 billion US dollars. The strategy of supply-side structural reform is being upheld and aims at further dismantling surplus capacities in production, excess housing stocks and cutting corporate debt. Plans are to increase production efficiency with a stronger focus on more complex components and high-technology fields. The targets set by the government in this area were largely met in 2018, according to the Chinese Statistical office.

The reform of state-owned enterprises is only progressing slowly due to the potential social consequences. The economic planners in Beijing are, in fact, ultimately working towards strengthening the public sector. The trend towards centrally planned mergers continues among state-owned enterprises in an effort to further consolidate the economy and prepare national champions for competition on international markets. Further large-scale mergers are to be expected in 2019 in the areas of transport, coal, telecommunications, energy supply and chemicals. These mergers, however, are mostly not relevant to international competition law, as the business activities of the companies are overwhelmingly geared to the domestic market.

Debt still a problem Despite regulatory intervention and continuing fiscal discipline, total debt is still one of China’s big problems. China’s debt ratio is currently between 250 and 300 percent of GDP according to different estimates. As a large proportion of the debt is concentrated on second-row banks on the domestic market and the state is both lender and borrower in many cases, the government has a wide scope for intervention. The private sector has lost liquidity due to the more stringent lending practices of the large banks. In a downturn, non-performing loans and the resulting snowball effects could become a risk to the system and thus also impact on foreign economic and financial flows. This would have global effects, not least on the German economy which is so closely intertwined with the Chinese economy.

On a positive note, the high foreign currency reserves continue to have a positive effect and still have a volume of more than three trillion US dollars.

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Growth or recession? | Global economy at a crossroads 05/03/2019

Structural market economy reforms still lacking Communist Party emphasised at its last congress in late 2017 that it aimed to strengthen its control of the economy and focus more on the public sector, thereby further dampening hopes of market economy reforms. But opposition is slowly growing to this approach. Not only do state interventions in the market and on corporate decision-making have a negative impact on the investment climate but they are increasingly upsetting China’s trade partners. The government has, in fact, taken individual steps towards following through on its pledges to increase free trade and further open up its markets. These include a reduction of import taxes on vehicles and consumer goods, a further opening up of the banking sector, and a new negative list for foreign investment. However, there is still no sign of structural market reforms. Foreign companies still face import taxes and restrictions on investment as well as rising non-tariff trade barriers. This primarily includes the Cybersecurity Law, which severely restricts the latitude in the digital market for foreign players.

European economy past its peak The European economy resoundingly failed to live up to year-start expectations in the course of 2018.

One-off factors contributing to the unexpected downward trend were the introduction of the WLTP test procedure for cars and the strikes by the “yellow vests� in France. Upward momentum already faltered tangibly in the first half of the year with all hard and soft factors pointing south from autumn onwards.

The euro area grew 1.8 percent in 2018. Real GDP growth in the 19 euro countries increased by 0.4 percent in the first and the second quarters each, before dropping down to 0.2 percent in the third and fourth quarters. The EU grew by 1.9 percent in 2018, rising by 0.4 and 0.5 percent in the first two quarters respectively, then dropping to 0.3 percent in both the third and the fourth quarters, compared to the previous quarter in each case. In its latest forecast (European Commission 2019), the European Commission has downwardly revised its growth forecast for the euro area, now only expecting real economic output to grow by 1.3 percent this year (1.6 percent in 2020) and 1.5 percent for the EU (and 1.7 percent in 2020).

Economic slowdown in almost all economies Germany only grew by 1.5 percent over the whole year, with negative real growth in the third quarter and stagnation in the fourth. One-off factors in automotive production contributed greatly to this slowdown. The transition to WLTP shaved around 0.4 percentage points off growth. In the current year, domestic drivers of growth will probably become even more significant. We are likely to see a robust expansion of the consumption expenditure of both private households and the state. Investment in plant and equipment may slow down a little, while R&D expenditure and construction investment should remain strong. Net exports are likely to make a negative contribution to growth.

The French economy also grew by 1.5 percent over the previous year (following 2.3 percent in 2017).

Fourth-quarter growth was down to only 0.3 percent. Domestic demand stagnated (0.1 percent) while net exports contributed 0.2 percentage points to growth. Overall, momentum certainly slowed during the year, but investment in plant and equipment rose 2.9 percent in the last six months of the year despite delayed corporate fleet investments and private consumption went up by 0.8 percent.

Construction activity, on the hand, stagnated. Public consumption rose by one percent. Exports went up 3.1 percent, thereby clearly outpacing imports, which increased by 1.1 percent. Net exports thus actually contributed 0.6 percentage points to growth. There was thus a marked slowdown in import growth compared to the previous year (2017: 4.7 percent), while exports only grew slightly less than

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Growth or recession? | Global economy at a crossroads 05/03/2019

the year before (2017: 4.1 percent). Inventories cut four tenths of a percentage point off growth. The French economy recorded an increase in gross value added of more than two percent in market-based services, while industrial gross value added only rose by 0.8 percent. Growth of around 1.5 percent seems feasible despite the darkening prospects for industry around the world on account of the dynamic aerospace industry, the recovery from WLTP in vehicle production, and the buoyant French service sector. The European Commission is only expecting growth of 1.3 percent.

Economic growth in Italy was particularly disappointing. This was no doubt partly due to the slowdown in global momentum and the export of components to the sporadically stuttering German automotive industry, but also because of the fiscal policy of the new government whose planned expenditure raised corporate financing costs. Overall growth for 2018 was one percent. In the second half of the year, Italy slipped into a technical recession (Q1: 0.3 / Q2: 0.2 / Q3: down 0.1 / Q4: down 0.2 percent quarter on quarter). The financial and economic policy decisions taken by the Conte government (increased expenditure for pensions and basic social security, lower investment in infrastructure, discontinuation of investment incentives, restrictive labour market regulations) may boost private consumption in the short term through new welfare benefits but will strongly stifle the investment activity in plant and equipment generated by the Gentiloni government despite slightly higher investment expenditure. For the current year, Italy is likely to fall short of the one percent forecast accepted by the European Commission, and its budget policy will thus fall foul of EU rules. A return to moderate growth of 0.5 percent will be challenging enough particularly given the negative business sentiment in the country.

The IMF recently revised its forecast to 0.6 percent, while the European Commission is now predicting growth of 0.2 percent. Consumption expenditure should still move upwards slightly, investments sideways and net exports are expected to hover at slightly above zero.

Spain’s economy proved very robust in 2018, growing by 2.5 percent over the previous year (following three percent growth in 2017). The economy expanded by 0.7 percent in the last quarter, thus continuing its steady path of growth throughout the year (Q1: 0.7 / Q2 and Q3: 0.6 / Q4: 0.7 percent).

All international organisations expect Spain to maintain this trend this year. A rate of well over two percent is definitely within reach (European Commission: 2.1 percent).

Whole euro area feels the downturn In 2018, economic development in the euro area was bolstered by robust investment activity, which increased by over three percent and contributed a good half a percentage point to growth. Private consumption rose by a comfortable 1.5 percent compared to the previous year, contributing almost one percentage point to growth. Employment grew by a robust 1.5 percent and now lies 2.6 percent above the pre-crisis peak in 2008. Unemployment dropped to 8.1 percent. There are now over nine and a half million more jobs in the euro area since economic recovery began in spring 2013. Net exports were also positive. The euro area is not only benefiting from the positive trend on the labour market but is also gradually feeling the positive impact of stronger corporate demand for credit produced by a supportive financing environment. The demand for loans has recovered steadily and is moving upwards at four percent compared to the previous year, according to the latest figures.

This year, economic growth in the euro area is endangered by a row of downward risks. Major factors that could lead to a deterioration of the current situation are weakening global demand, the low momentum in foreign trade and a disorderly exit of the United Kingdom from the EU. Economic growth should remain robust in France, the Netherlands and Spain and in almost all countries in northern and eastern Europe. The outlook for Germany and Italy, on the other hand, is clouded by the swiftly

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Growth or recession? | Global economy at a crossroads 05/03/2019

weakening level of industrial activity. In view of the weak figures coming from foreign trade, in particular, and the pronounced downward turn of leading indicators, growth will probably only reach 1.25 percent, and only in the event that the UK does not crash out of the EU. A disorderly exit would cost the euro area at least half a percent of growth and could easily trigger a recession. Aside from Brexit, it is very difficult to predict to what extent the downturns of the last few weeks in incoming orders, foreign orders and freight levels will continue. Net exports could pull down growth in 2019 and 2020 after remaining positive for the last two years. There are many indications that companies from the euro area will lose market shares as the phase of improved price competitiveness between 2015 and 2017 gives way to normal adjustment with increasing wages (Deutsche Bank Research 2019).

After rising to two percent in November 2018, inflation in 2019 is likely to come in slightly lower than the ECB’s forecast rate of 1.6 percent in view of falling oil prices and the general slowdown. The European Commission recently cut its forecast for the euro area for this year to 1.4 percent (down from 1.8 percent). Core inflation, which measures the increase in prices excluding energy and food, is also likely to stay below 1.4 percent. Other inflation indicators are not pointing upwards either according to the latest figures. Wages in the euro area nonetheless increased by 2.5 percent in the third quarter (after 2.2 percent in Q2). Buoyed by services, the public sector and the construction sector as well as industry, this should cause core inflation to rise in the medium term even if industrial activity drops off.

Euro area: Growth in real GDP in percent 3 2,4 2,3

2,1

2,0

1,8

1,8

2

1,9 (P)

1 0,3 0 -0,4 -1 I

II III IV I

II III IV I

II III IV I

II III IV I

II III IV I

II III IV I

II III IV I

II III IV I

II III IV

2010

2011

2012

2013

2014

2015

2016

2017

2018

change over previous year quarter Veränderung ggü. Vorjahresquartal

change over previous quarter Veränderung ggü. Vorquartal

change over previous year Veränderung ggü. Vorjahr

Source: Macrobond

Japan set to remain on course of moderate expansion Japan had to cope with several natural disasters in 2018. Its economy nonetheless remained robust, growing over its potential at one percent in real terms. The country is heading for similar growth this year. Consumption expenditure of private households and investments should both pick up pace slightly, while public investment and net exports are likely to pull growth down. Exports and industrial production should also experience moderate growth. The government intends to hike up value-added tax from eight to ten percent in September but will mitigate the contractive impact on consumption expenditure by at least 50 percent through tax breaks and higher public expenditure. It also plans to increase regulation on overtime and put further pressure on the labour market. Unemployment was at

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Growth or recession? | Global economy at a crossroads 05/03/2019

only 2.4 percent at last count, with only 1.5 million unemployed persons in a country with 69 million employed persons and one million vacancies. Wages seem to have increased rather more dynamically in the last few years than had been assumed until now as the estimates of the country’s statistical office were skewed due to flawed surveying methods. Inflation is likely to be around one percent for the year overall due to the increase in value-added tax.

Regional outlook This year, growth in emerging and developing countries is set to remain roughly level with the previous year. The IMF is expecting 4.5 percent real economic growth compared to the previous year, following 4.6 percent in 2018 (IMF 2019). In view of falling oil prices, India should also accelerate its growth somewhat while its Asian neighbours may lose steam slightly but should still grow at a very robust pace of over six percent. Russia should manage to grow by a good one and a half percent, with the other CIS countries heading for over 3.5 percent. Turkey is in for a recession this year, as is Argentina.

The biggest improvement should be seen in Brazil. Following a recession and moderate recovery, growth in Brazil should pick up to 2.5 percent this year. Latin America would thus grow overall by around two percent. Mexico’s growth will be heading the other way, dropping to a good two percent.

Two and a half percent growth seem feasible for the countries of the Middle East, Afghanistan and Pakistan, although low oil prices and a series of problems in foreign and security policy are keeping the lid on momentum. Sub-Saharan Africa should gather pace by at least half a percentage point and grow in real terms by around 3.5 percent, with non-oil producers likely to outpace oil producers.

Regional economic outlook* 2019 South America

1.9

Central America

3.8

Caribbean

3.7

Asia-Pacific, advanced economies1

1.8

Asia-Pacific, developing economies2

6.3*

CIS-States3

2.2*

Middle East, North Africa, Afghanistan, Pakistan

2.4*

Israel

3.5

Sub-Sahara Africa

3.5*

1Japan, South Korea, Taiwan, Singapore, Hong Kong, Australia, New Zealand, Macau 2 including China and India 3 Russia, Ukraine, Georgia, Turkmenistan, Caucasian und Central Asian States * Growth of real GDP over previous year in percent Source: IMF (October 2018; *January 2019)

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Growth or recession? | Global economy at a crossroads 05/03/2019

Consequences for Germany The latest data for production, incoming orders and foreign trade confirm the general picture of weakening economic momentum. Industrial production only increased by 1.2 percent in 2018 over the previous year. Incoming orders stagnated over the previous year, although admittedly the period from the summer months of 2016 to February 2018 had been exceptionally strong. The current downward trend in the latest figures is more worrying. The export of goods, on the other hand, increased by three percent compared to the previous year despite the one-off effects from the automotive industry. While robust, this performance was slightly below global trade growth. Imports were very dynamic, rising by 5.7 percent. Some economic sentiment indicators have been very weak recently, particularly for manufacturing, but we should bear in mind that they had been extremely high one year ago. With little hard data available at this point, it is not possible to reliably assess whether the economic situation and business prospects have really deteriorated so rapidly and strongly.

In view of the manifold risks in the year ahead and cloudier economic prospects, the federal government has cut its forecast to one percent growth in its annual economic report, lowering its expectations for plant and equipment investment and real exports in particular. The adjustment comes as no surprise as the previous forecast for 2019 was 1.8 percent (Federal Government 2019).

It is true that since last autumn, many economic indicators have become weaker and the downside risks to our forecast for real economic output of 1.5 percent growth against the previous year have increased. We will review our forecast once the complete annual results are available in early March.

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Growth or recession? | Global economy at a crossroads 05/03/2019

Sources BEA (2018a). GDP Increases in the Third Quarter. 21 December.

--- (2018b). Gross Domestic Product. 5 February.

Bundesregierung (2019). Jahreswirtschaftsbericht 2019. Januar. Berlin.

CBO (2019a). The Budget and Economic Outlook: 2019 to 2029. 28 January.

--- (2019b). The Effects of the Partial Shutdown Ending in January 2019. 28 January.

Committee for a Responsible Federal Budget (2019). Q&A: Everything You Should Know About Government Shutdowns. 7 January.

Deutsche Bank Research (2019). Focus Europe. Euro area: the threat from trade. London.

25 January.

European Commission (2019). European Economic Forecast. Winter. Brussels.

European Central Bamk (2018). Economic Bulletin. December. Frankfurt/M. International Monetary Fund (2019). World Economic Outlook. Update. Washington, D.C. January.

--- (2019): World Economic Outlook, February.

Lardy, Nicholas (2019). Xi’s turn away from the market puts Chinese growth at risk. Financial Times.

16 January.

Netherlands Bureau for Economic Policy Analysis (2019). World Trade Monitor. February.

OECD (2018). Economic Outlook. November. Paris.

Summers, Lawrence (2019). We must prepare now for the likelihood of a recession. Financial Times.

8 January.

UNCTAD (2019): Investment Trends Monitor Issue. 31 January.

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Growth or recession? | Global economy at a crossroads 05/03/2019

Imprint Bundesverband der Deutschen Industrie e.V. (BDI) Breite Straße 29 10178 Berlin T: +49 30 2028-0 www.bdi.eu Authors Dr. Klaus Günter Deutsch T: +49 30 2028 1591 k.deutsch@bdi.eu Julia Howald T: +49 30 2028 1483 j.howald@bdi.eu Thomas Hüne T: +49 30 2028 1592 t.huene@bdi.eu Wolfgang Krieger BDI-Vertretung, Peking T: +86 1085 3258421 w.krieger@bdi.eu Valerie Ross T.: +49 30 2028 1623 v.ross@bdi.eu Dr. Christoph Sprich T: +49 30 2028 1525 c.sprich@bdi.eu Editorial / Graphics Marta Gancarek T: +49 30 2028 1588 m.gancarek@bdi.eu

This Global Growth Outlook is a translation based on „Globaler Wachstumsausblick“ as of 15 February 2019.

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