A thick fog of political uncertainty

As 2018 draws to a close, the global economic recovery is losing momentum, slowed by the headwinds of tighter financial conditions, pockets of capacity constraints and heightened policy uncertainty. The impact of these headwinds on individual economies, moreover, has been asymmetric with those suffering large external imbalances, such as Turkey and Argentina, hardest hit. On a more positive note, a strong impulse coming from fiscal expansion in the United States, targeted policy accommodation in China and still accommodating monetary policies in Europe and Japan are supportive factors looking ahead to 2019.

The recent decline of oil prices is also welcome news and our forecast is for the major economies to still enjoy firm growth in 2019 of 3.0%, after 3.3% in 2018 in real terms. A particularly thick fog of policy uncertainty, however, hangs over this scenario, be it in relation to trade tensions, Brexit, the Italian budget debate, the CDU leadership elections in Germany or the European Parliamentary elections, and the coming months will be key in shaping not just the outlook for 2019 but also well beyond.

The US mid-term elections on 6 November left the Senate majority in the hands of the Republicans but shifted the House majority to the Democrats. On the domestic front, this is likely to leave the Republican policy ambitions largely gridlocked, with infrastructure spending as the one potential source for upside surprises. On the international front, President Trump is due to meet President Xi at the upcoming G20 Summit on 30 November and while there is little chance for a fast-track resolution of the trade tensions between the United States and China, hope is that the return of dialogue will put plans for future US tariff increases on hold.

Michala Marcussen, Societe Generale’s Group Chief Economist

Michala Marcussen, Group Chief Economist

The European Union (EU) also hopes to conclude trade talks with the United States favourably, but closer to home more pressing issues loom. Brexit tops the list with the clock ticking fast for a deal to be reached, thus securing an orderly transition period and avoiding a disruptive no-deal Brexit that would plunge the United Kingdom into recession with inevitable negative spill-over to the rest of Europe. In close second, we find the ongoing tensions between the Italian government and the European Commission over Italy’s newly presented economic programme. The most worrisome feature of the programme is the absence of the type of economic reforms that could deliver a much-needed boost to Italy’s structurally low growth.

Turning to the euro area, both the Brexit talks and the Italian budget tensions are slowing much needed progress on the completion of the European project, but these are not the only obstacles. In Germany, Chancellor Merkel decided to step down as CDU party leader after a devastating loss for her party in the Hesse state election, paving the way for a CDU leadership election on 7 December. While Merkel has no immediate plans to step down as Chancellor, the reality is that Germany could be facing a new election well before the next election is due in October 2021. The new CDU leader’s position on Europe will be closely watched across the continent as will the European Parliamentary elections taking place on 23-26 May 2019. Both events will be key in shaping the European project and Europe’s position on the international stage over the coming years.

In the near-term, this thick fog of political uncertainty comes with very real economic consequences as business managers and consumers alike generally hold back on major investment, hiring and spending decisions when faced with uncertainty. This effect has been particularly visible in the United Kingdom, but can also be observed in those economies closest to the political uncertainties discussed above. Financial markets often mirror sentiment in the real economy and a certain sense of caution is likely to prevail until the political uncertainty lifts. Focus then is likely to shift back to central banks. Assuming that the most adverse political outcomes are avoided, the underlying firm stance of the major economies should allow the major central banks to pursue gradual policy tightening in 2019, with the Federal Reserve in the lead, followed by the European Central Bank, the Bank of England and, albeit it ever so gradually, even the Bank of Japan.

Article written 07.11.2018