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Political tensions ahead

Advanced economies are expected to continue to grow moderately, while monetary policies look set to remain loose.

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Editorial

Political tensions ahead

Some three months after the Brexit vote, the fog is only slowly lifting. In July, the UK Purchasing Managers Index (PMI), a sentiment indicator, dropped 4.8 points to 47.6 only to recover ground in August with a rise to 53.6 points. The majority of purchasing managers have regained their optimism. This may partly reflect the cut in interest rates by the Bank of England (BoE), which also encouraged consumers to continue spending and stabilized the real-estate market.

UK: Lower investment hinders growth

Already, uncertainty related to the Brexit vote has unsettled British companies.

UK: Lower investment hinders growth

Sources: Bank of England, Thomson Reuters Datastream; as of 09/20/2016.

Exports were also supported by the collapse of the British pound. In light of this, we raised our 2016 growth outlook for the United Kingdom from 1.3% to 1.8%. Longer-term, the Brexit threat is expected to be a drag on the economy. It remains unclear what type of access the United Kingdom will be granted to the market of the European Union (EU), partly because the country has yet to clarify its policy on the free movement of people, an EU requirement for single market access. Such uncertainties lead to lower investment, which puts pressure on both the labor market and on consumer spending, ultimately slowing growth.

European Union holds steady

Fears that the Brexit vote would lead to a political destabilization of the EU proved to be exaggerated. It has, however, prompted increased political discussion on reforms to strengthen both the EU and the Eurozone. For now, consensus continues to dominate decision-making within the EU and the Eurozone, which tends to slow down the pace of reforms considerably.

A gradual improvement

The unemployment rate falls and the number of employees rises, increasing the scope for moderate wage increases.

European Union holds steady

Sources: Eurostat, ECB, Thomson Reuters Datastream; as of 09/20/2016.

We have raised our growth forecast for the Eurozone by 10 basis points to 1.5%, which also reflects the solid performance in the first two quarters of 2016. Gradual improvements in the labor market and an uptick in wages is supporting consumption, which remains the economy’s key growth driver. Further stimulus, though limited, is coming from the fiscal side.

In 2017, we expect growth to slow mildly. With more than 7% of the Eurozone’s exports destined for the United Kingdom, the flow of these exports is bound to come under pressure from the uncertainties brought on by Brexit. Additional pressure may also result from other political uncertainties such as Spain’s struggle to form a government, the constitutional reform in Italy in the fourth quarter and the U.S. presidential election. The Netherlands, Germany and France plan to all hold presidential or parliamentary elections in 2017. This, together with the geopolitical crises in the Middle East and the Ukraine, continue to take a toll on investment.

Central banks remain on hold

Moderate growth and low inflation should persuade the European Central Bank (ECB)at its December meeting to extend quantitative easing (QE)until September 2017. The ECB does caution however that an expansive monetary policy alone cannot boost underlying economic growth rates – this would require structural reforms. Such reforms have been introduced in several Eurozone countries, but the pace of reforms remains too slow.


Among the large advanced economies, Japan remains a laggard. Despite government spending programs and an enormously expansive monetary policy, Japan’s economy is expected to grow just 0.7% in the coming year. Consumer prices are anticipated to rise by only 0.2%. Overly tight regulation and a shrinking working-age population continue to dampen economic dynamism.

Shrinking inventories reduced U.S. economic growth in the first half of 2016, but this drag seems to have run its course. Now, the focus is turning to the labor market. With unemployment low, labor market participation rising and wages picking up, economists expect consumption to trend higher. In prior quarters, corporate reluctance to invest had a dampening effect on growth. This partly reflected the investment slump in the energy and mining sectors following the collapse in key commodity prices. Now that commodity markets have stabilized, the effect of lower investment should level off.

Eurozone: Still room before full employment

The actual U.S. unemployment rate suggests the U.S. is at full employment, but there is still potential to improve.

Eurozone: Still room before full employment

Jobs gap = Actual unemployment rate – estimated natural rate of unemployment, Participation gap = Actual employment rate – estimated cyclically adjusted employment rate, Full-time jobs gap = 1/2 * (part-time workers interested in full-time employment - level prior to recession). Sources: Congressional Budget Office; U.S. Department of Labour; as of 09/20/2016.

Based on our estimates, the U.S. economy should grow by 2% in 2017, accompanied by a rise in the core rate of inflation to 1.8%. This would allow the Federal Reserve to steadily pursue its chosen course for U.S. monetary policy. In December 2016, we expect a 25 basis point rise in the federal funds rate and one further 25 basis point increase during the first three quarters of 2017. Even after these increases, the benchmark rate would remain at an historically low level.

Our forecasts

The global economy is growing at a subdued pace. While stability is returning to the emerging markets, advanced economies are losing momentum.

The global economy should continue to grow moderately in 2017, whereby a higher share of this growth is expected to come from emerging economies. One reason is that emerging countries exporting raw materials are getting support from the stabilization in commodity prices. Another is that many of the emerging countries have started reforms. China’s economy on the other hand is losing some steam.

GDP growth rate (in %)

GDP growth in % (year-on-year)

  Region 2016F 2017F

United States

1.5

2.0

Eurozone

1.5

1.2

United Kingdom

1.8

0.8

Japan

0.5

0.7

China

6.3

6.0

World

3.3

3.4

Fiscal balance (in % of GDP)

Fiscal balance (in % of GDP)

  Region 2016F 2017F

United States

2.8

3.0

Eurozone

1.9

1.9

United Kingdom

3.5

4.0

Japan

6.0

5.2

China

2.4

2.5

Inflation in % (year-on-year change)

Consumer price inflation (in %)

  Region 2016F 2017F

United States1

1.6

1.8

Eurozone

0.2

1.5

United Kingdom

0.7

2.4

Japan

-0.2

0.2

China

2.0

1.5

Current-account balance (in % of GDP)

Current-account balance (in % of GDP)

  Region 2016F 2017F

United States

-2.7

-2.9

Eurozone

2.9

2.7

United Kingdom

-5.5

-4.5

Japan

2.8

2.5

China

2.5

2.5

Benchmark rates in %

Benchmark rates

  Region Current* 2017F

United States

0.25-0.50

0.75-1.00

Eurozone

0.0

0.0

United Kingdom

0.25

0.10

Japan

0.0

0.0

Commodities

At its meeting in late September, OPEC agreed to limit oil output to 32.5 million barrels per day in the hopes of preventing member countries from expanding production. This, combined with production cuts in the United States, is expected to reduce the supply of oil slightly in 2017, whereas demand is anticipated to moderately increase. We foresee a moderate rise in the oil price to $55 per barrel of crude oil (WTI) by September 2017. Gold performed well in the first three quarters of this year supported in part by the Brexit vote and upcoming elections in both the United States and the European Union, which have unsettled the markets. Low government- and corporate-bond yields, which are presumed to continue, are making gold more interesting, but the upward trend is likely to flatten significantly in the coming 12 months. Gold prices may experience setbacks if the Fed raises interest rates.

Executive summary: Given the oil market’s fundamentals and inventory levels, we expect a moderate rise in the oil price. Gold stands to benefit from current political uncertainty and low interest rates.

Our forecasts

Commodities

  Commodities in U.S. dollars Current* 2017F

Crude oil (WTI)

45

55

Gold

1,327

1,375

Silver

19

20

Copper (LME)

4,787

4,500

Aluminum (LME)

1,651

1,500

ref-1

F refers to our forecasts as of 9/22/16.

ref-2

1core rate, personal consumption expenditure Dec/Dec in % (no average as for the other figures).

ref-3

*Source: Bloomberg Finance L.P.; as of 9/27/16.

ref-4

Source: Deutsche Asset Management Investment GmbH; as of 10/7/16.

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