Not looking for a sharp shock

I would urge for caution.

Not looking for a sharp shock

Tony Ward is chief executive of Home Funding

Some good news this week. The World Bank said global economic growth is likely to speed up this year after a stronger than expected 2017. The bank's new forecast is that the world economy will expand by 3.1% in 2018.

Its president Jim Yong Kim said that ‘the broad-based recovery in global growth is encouraging’ and that the forecast is better than the bank’s expectation in its previous assessment last June.

All positive stuff then. But – and this is a big but – the World Bank suggests that this will be the high point of a temporary cyclical recovery; underlying structural problems will make themselves felt in the next decade.

The forecast is that the global economy will fall into a decade of sluggish growth in the 2020s as the current upswing fades and a slowdown in population kicks in.

The really important issue is whether the world economy will have the capacity to maintain decent growth beyond the current upturn. The bank says that its potential is growing more slowly than it used to.

So how come? Well, a number of factors but the bank cites weak productivity growth across the world, poor levels of investment and the ageing global workforce which will all have a negative impact on GDP growth.

Franziska Ohnsorge, economist at the World Bank, said: “If you look backwards 10 years, potential growth has slowed by about one percentage point globally. Looking forwards we expect it to slow further. Potential growth for the next decade is estimated at about 2.3%.”

And this forecast is based on a relatively benign scenario in which none of the big risks to growth materialise.

Interestingly, the World Bank believes the biggest risk comes in financial markets. It suggests that if inflation rises only slowly then markets stay safe.

However, if prices rise more rapidly than expected and central banks have to raise rates, the Bank believes that this can cause a crash.

“If there is a surprise in monetary policy decisions there could be jitters in global financial markets. And markets are currently vulnerable to unforeseen negative news. This is the main risk we see to the global economy,” said Ms Ohnsorge.

Stock prices are high relative to earnings and volatility at historic lows, which certainly may be warning signs. ‘’There is a sense in which financial markets appear to be complacent. That makes room for disruption when there are surprises – a repricing of risk.”

Her warning echoes those of institutions including Legal and General Asset Management, which fears the US economy and markets will surge ahead this year before rate hikes burst the bubble and trigger a widespread recession.

Willem Buiter, economist at Citi, also fears the business cycle is nearing its end and a market correction is overdue.

Just this weekend, Fitch warned that interest rates in the US could shoot up much faster than expected over the next 18 months.

The credit ratings agency suggested that the US Federal Reserve’s base rate could rise to 3.25% by Autumn next year, smashing through the 3% mark at least a year before the average Fed policymaker’s forecast.

Fitch’s forecast includes four rate rises this year, double the two markets currently anticipate.

Our impression of the Fed is that it wants to get on with this, and the rationale for leaving rates lower for longer has disappeared,” said James McCormack, in charge of sovereign ratings at the agency. “We think rates are going to move higher than the market believes they will.”

However, Fitch fears that a steep rise in rates could have significant implications for corporations and governments trying to raise more debt. Citigroup analysts also warned last week that tighter monetary policy could stun global markets.

Elsewhere we have the European Central Bank hinting at an early end to its huge stimulus programme with the prospect of the ECB’s guidance being ‘revisited’ early this year raising the prospect that its quantitative easing programme could be withdrawn sooner than thought.

I have to say all this activity is making me feel more than a little nervous. I think there is a danger that the rug could metaphorically be pulled from under our feet if rates rise too fast and stimulus is withdrawn too soon.

I would urge for caution. Otherwise, as the World Bank suggests, any unexpected rise in rates could deliver a sharp shock to borrowers and cause ‘turmoil’ in the years ahead.