Precisely what Donald Trump’s Presidency will mean for the global economy remains far from clear. For the time being, investors are giving him the benefit of the doubt, assuming that he will ditch some of the wilder policy proposals touted on the campaign trail while pricing-in the likelihood of a hefty fiscal stimulus along with a dose of business-friendly deregulation. It’s questionable whether expectations in that respect will be fulfilled. But as those measures would, at least for a while, boost US economic growth and inflation, investors also now expect the Fed to raise rates more rapidly than previously seemed likely, sending the dollar sharply higher and pushing up bond yields within and well beyond the US. Indeed, in the euro area, yields on 10Y German Bunds have risen significantly since the US election, recently briefly moving back above 0.3%, about 50bps above their summer low, for the first time in more than six months, while yields on 10Y Italian government bonds are now firmly above 2% for the first time in a year, more than 100bps above their recent low reached just three months ago.
But while GDP growth and inflation in the US might well get a near-term impetus from Trump’s initiatives, hopes of significant new budgetary stimulus this side of the Atlantic will be dashed. Admittedly, last week the European Commission proposed that euro area governments provide a co-ordinated fiscal boost worth about ½% of GDP. But while that would be dwarfed by the stimulus proposed by Trump, even such a modest package looks impossible to deliver. Crucially, euro area countries with fiscal ‘room for manoeuvre’, notably Germany, have no intention of loosening their purse strings. And while Italy aims to relax policy somewhat – partly to fund reconstruction after recent earthquakes and to meet the rising costs of the migration crisis – governments in France and Spain remain committed to tightening by at least ½% of GDP in an attempt to meet their obligations under the euro area’s budgetary rules. So, in marked contrast to the US, the overall euro area fiscal stance in the coming year will be effectively neutral, with the ECB still left alone in trying to boost growth and inflation.
Of course, some euro area exporters might expect to benefit from stronger demand from the US over coming quarters, as well as improved competitiveness resulting from the post-election depreciation of the euro against the dollar to a more than one-year low below $1.06. However, with the US accounting for less than 15% of euro area exports, firmer demand from across the Atlantic would likely have only a modest direct impact on euro area economic growth. Indeed, exports from the euro area to emerging market countries are worth more than three times the value of those to the US. And for many in the EM universe, the upwards shift in the dollar and global bond yields resulting from Trump’s fiscal policy could well spell trouble given their high level of (often foreign currency-denominated) debt. Indeed, weakness in demand from EM countries weighed significantly on euro area exports and production through the second half of 2015 and first half of 2016. And while evidence had pointed to a firming in demand from those countries in Q3, the recent tightening of financial conditions, pressures on exchange rates and capital outflows might well shift that trend back into reverse, more than negating any boost in euro area demand provided by trade with the US.
On balance, therefore, we doubt that Trump’s election will have any significant positive impact on economic growth in the euro area. And, judging from the President-elect’s anti-globalisation rhetoric, his policies may end up downright harmful. To be sure, like US participation in the Trans-Pacific Partnership (TPP), the Transatlantic Trade and Investment Partnership (TTIP) between the EU and US now looks dead. And, whether the focus of his ire turns to Mexico, China or indeed Europe itself, should Trump resort to some of the most protectionist measures threatened during his campaign, global trade, which has already been shrinking over the past year or so, would risk a downward spiral, with highly adverse consequences – in terms of economic growth and productivity, inflation and living standards – for all major exporting economies, the euro area and US included.
But while Trump’s policies may or may not have a notable impact on Europe’s economic outlook, the principal risk this side of the Atlantic is, of course, posed by forthcoming political events, the outcomes of which – following the Brexit referendum and Trump election – are now difficult to predict with any confidence.
We are not so concerned about developments in Germany. After Angela Merkel confirmed on the past weekend her intention to seek a fourth term as Chancellor, we expect her to triumph at the general election next autumn, although her next government will likely be a relatively weak one. And in France, the centre-right Republican party candidate at the spring Presidential election now looks set to be the Thatcherite former Prime Minister François Fillon, whose conservative social and foreign policies might help draw support away from the far-right Marine Le Pen. We take some comfort from surveys showing that the majority of French voters support EU membership. But, in a world where voters are keen to kick back against establishment politicians, while it is very much an outside bet, a victory for Le Pen – who has promised a referendum on French EU membership, the outcome of which could destroy the euro area and EU – cannot be completely ruled out.
More imminently, however, the desire of voters to give leaders a bloody nose looks set to result in defeat for Italy’s Prime Minister Matteo Renzi in the referendum on constitutional reform on 4 December. If that is indeed the outcome, it remains to be seen whether Renzi would follow through on his previous pledge to resign, a move that would risk political crisis in the euro area’s third largest member state. In the event that the constitutional proposals are rejected in the referendum, the pursuit of an alternative electoral reform – to favour the establishment of coalition rather than single-party governments – might help to limit the damage. But the possibility of a snap general election that could feasibly bring victory for the populist and unpredictable Five Star Movement – which has advocated a consultative referendum on Italian membership of the euro – might still generate heightened risk aversion in financial markets and could, like a Le Pen Presidency, ultimately end in crisis.
That Italian referendum will take place just four days before the ECB Governing Council’s December meeting. With recent economic sentiment surveys from the region broadly encouraging, policymakers will likely forecast that GDP growth in the euro area over the next couple of years will remain close to the 1.6%Y/Y rate of the third quarter. They are more concerned, however, by weaker-than-expected wage growth and the resulting lack of underlying price pressures. And while the members of the Governing Council will expect headline inflation to rise over coming months from just 0.5%Y/Y in October as the effects of past shifts in energy prices continue to fade, they will also expect it to remain some way below the ECB’s target of close to 2%Y/Y over the forecast horizon.
So, while the Federal Reserve now seems bound to tighten US monetary policy next month, before that move the ECB is set to add extra stimulus, most likely by extending its asset purchases at the current rate of €80bn per month beyond next March for a further six months. And although the recent upwards shift in yields has diminished somewhat concerns about the scarcity of bonds available for it to buy, and it also looks set to amend its securities-lending facilities to support market liquidity, to ensure it can meet its ongoing commitments the ECB will also need to relax the rules of the QE programme, most likely by increasing the self-imposed issue share limit for bonds without collective action clauses. Of course, if politicians on either side of the Atlantic provide a new adverse shock to the global economy and/or financial markets, the Governing Council’s December meeting is unlikely to mark the final chapter for this easing cycle. Instead, the ECB might yet need to keep buying assets for a very long time to come.
*This article was originally written for and published in Japanese by NNA Europe (http://europe.nna.jp)