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Is the trade war disruptive, or is it merely accelerating trends already underway?

Monetary policy – which did the heavy lifting in the aftermath of the global financial crisis – has reached its limits.

The outcome of the upcoming European elections on 23-26 May 2019 could have a significant bearing on the eurozone’s ability to tackle the next economic downturn

The Bank of England was on hold today, as largely expected, and the MPC unanimously voted to keep policies unchanged.

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Emerging markets contended with a challenging backdrop in 2018, amid less accommodative global financial conditions, slowing economic growth in China and fraught US-China trade relations.

For all the resounding announcements, catchy slogans and jokes, today’s Budget amounted to little in practical terms. Chancellor Philip Hammond announced “a Budget for Britain’s future” and reiterated that, after almost a decade of spending cuts, fiscal austerity was “coming to an end”, as also suggested by the Prime Minister during the Tory party conference early this month. Alas, it is not happening now, it is only vaguely defined in practical terms, and it is conditional on a good Brexit deal.

The Bank of England kept policy on hold at today’s meeting, as widely expected. It has nudged up its Q3 GDP expectation, yet, by warning that Brexit uncertainty has increased even since August, the MPC could stay put on rates in the near future, as Brexit negotiations approach a crucial stage – including a soft deadline for a withdrawal deal in mid-November. Yet, the Bank has maintained a mild tightening bias, suggesting that a “gradual and limited” hiking cycle is appropriate under most circumstances going forward. Having increased rates at its August meeting, the Bank is likely to hike once again over the next year, provided Brexit negotiations proceed smoothly. Justifying higher rates has been a sober take on the supply side of the economy: in a context of sluggish potential growth, the limited spare capacity left in the economy is quickly disappearing, and excess demand is building. In order to avoid a last minute overreaction to inflationary pressures likely to emerge down the road, and taking into account the fact that monetary policy works with a lag, the Bank look still to be eyeing around three rate hikes in the next three years. That would take the Bank rate up to their estimate of short-term equilibrium, currently seen between 1.5% and 2%. This equilibrium rate (r*), defined as that needed to keep the economy on an even keel, is expected to rise to 2-3% thereafter. The logic being that faster productivity growth spurs wages, and leveraging continues to pick-up.

The trade tariffs – and corresponding retaliatory measures – implemented are so far limited. In total, the value of affected trade now amounts to about $150bn globally, or 0.8% of overall world exports. However, adding up all the measures currently under discussion and assuming impacted countries retaliate commensurately, the amount of targeted trade could quickly rise to more than $1tn, or 6% of global exports. In her latest Ahead of the Curve, Silvia Dall’Angelo, Senior Economist at Hermes Investment Management, argues an escalation of protectionist measures evolving into a trade war could represent the biggest challenge to the world economy.

While Italy’s short-term economic outlook includes some positive elements, material downside risks loom amid high policy uncertainty. In her latest Ahead of the Curve, Silvia Dall’Angelo, Senior Economist at Hermes Investment Management, argues the Italian situation is a symptom of deep-rooted malaise and requires a credible and concerted response. Italy’s recent political imbroglio reignited the debate over the European Union’s (EU) future and the viability of the European single currency within its current institutional framework. While the situation has normalised, the landscape in Italy remains fragile. It is emblematic of the challenges the Eurozone is facing in a new political era. This new political backdrop emphasises national sovereignty, has an inward-looking approach and favours centrifugal forces, posing hurdles to European integration. Effects of the crisis Italy’s double-dip recession – the global financial crisis in 2008, followed by the European Sovereign Debt Crisis in 2012/13 – was particularly severe, as the country was ill-equipped to deal with it in the first place. The typically short-lived political cycle – with 65 administrations at the helm since World War II – has favoured wasteful public spending and quick fixes, rather than long-sighted structural reforms. In this context, public debt grew quickly, thereby reducing the fiscal space available at times of crisis.

The headline-grabber outcome of the ECB meeting today was the announcement of an end-date for the QE programme: the ECB now anticipates net purchases to grind to a halt at the end of this year. However, the decision was hardly a surprise, following the hints from the ECB’s Chief Economist Peter Praet two weeks ago. Importantly, the ECB made sure to keep in place significant accommodation by strengthening its forward guidance on rates and it retained plenty of flexibility should circumstances change going forward. As largely expected, the ECB announced an extension of QE net purchases at a slower monthly pace of €15bn after September and until the end of the year. According to Draghi, recent “substantial progress” in the inflation adjustment towards the ECB’s 2% target justifies further tapering and the conclusion of the QE programme. Of course, the process is conditional on development in incoming data but it feels like the bar for disappointment is quite high. Other tools remain in place to facilitate the inflation adjustment, most notably a strengthened forward guidance stating the first rate hike will take place in summer 2019 at the earliest. In addition, the stock of ECB holdings – set to hit €2.6tn (22% of GDP) by the end of the year – will remain large, as the reinvestment policy will persist for an indefinite time.