UniCredit Outlook 2016
Europe gains traction on domestic demand: we like risky assets and see limited euro downside
Authors: Erik F. Nielsen, Group Chief Economist & Global Head of CIB Research, UniCredit Group and Edoardo Campanella, Economist, UniCredit Bank AG, Milan
In this report, we present our revised 2016 and brand-new 2017 forecasts for the global economic outlook and financial markets. Importantly, our calculations were concluded shortly before the terrorist attacks in Paris on 13 November. These tragic events add uncertainty to the outlook, as both the policy response and private sector sentiment remain unknown. However, on balance, we think the baseline forecast for the trend through 2016-17, as discussed here, remains broadly correct.
We expect the eurozone recovery to gain strength in 2016, reaching an annual average GDP growth rate of 1.9%. This above trend (and above consensus) growth outlook will continue to be powered mainly by domestic demand, which should make up for a difficult external environment. This year’s boost to real income from low inflation will be replaced by income growth from stronger labor markets. Fiscal policy has also now turned slightly expansionary, partly due to the refugee crisis, and fixed investment is beginning to take off.
In country terms, we forecast growth acceleration in Germany (to 2.0% from 1.5%, in working-day-adjusted terms), France (1.5% from 1.2%) and Italy (1.4% from 0.8%). In Spain, the recovery will probably level off somewhat after a very strong 2015 (2.9% from 3.2%). Germany’s outperformance over the rest of the eurozone will remain in place, but it is likely to be very moderate compared to the past — mainly as a result of slow growth in emerging markets (EM) — and in 2016 it will be helped by higher spending related to the influx of refugees. Italy’s growth gap vis-à-vis the rest of the eurozone is likely to continue to narrow as the transmission of monetary policy improves and fiscal policy becomes outright expansionary, even without the refugee effect.
This growth outlook will make further inroads into the eurozone’s still excessively large output gap. Core inflation will therefore continue to climb higher, but at a snail’s pace. In our forecasts, headline inflation is unlikely to reach the ECB’s target of below, but close to, 2% in the next two years. These subdued inflationary developments in the coming year prompted the ECB Governing Council at its December meeting to approve an additional stimulus package, which included a 10bp cut in the deposit rate and a six month extension of the purchase programme, worth about €350bn. Should more accommodation become necessary, the ECB would look at both QE3 and rate cuts with an open mind. Another leg of QE expansion would require an increase of the ISIN concentration limit or a move to purchase debt in less liquid markets. Given its potentially contentious implications, we still regard any material departure from a QE framework based on capital keys as unlikely.
Outside the eurozone, we expect the picture to remain mixed. The US economy will remain one of the major engines of global growth in 2016. We expect real GDP growth to average 2.6%. With a narrowing output gap and a tighter labor market, we expect the Federal Reserve to start raising its target rate at the upcoming meeting in mid-December, followed by three more rate hikes in 2016.
In clear contrast to present market sentiment, we think the euro is about to bottom out, and that it will be stronger again in the second half of 2016 as the current account surplus and real money flows into cheap European assets.
The UK is one of the few OECD countries for which we forecast slower and below consensus growth for 2016 (at 1.9%). This is mostly because the UK is simply running out of spare capacity and partly because of domestic and external headwinds. We expect the first Bank of England rate hike to occur in May 2016, followed by further hikes of 25bp per quarter.
Central Europe is also likely to enjoy another year of above trend growth in the 3.0-3.5% range, while the contraction in Russia is likely nearing an end. We expect a slightly higher growth rate also in Turkey, but it will remain well below its pre-2013 heyday.
Emerging markets will continue to be laggards in the global growth picture. We expect EM to be through the trough, which should be followed by marginally higher growth rates in 2016 than in 2015. China will probably continue to slow moderately, but GDP growth is expected to stabilise somewhat above 6%. With the authorities fully committed to cushioning the near term slowdown, China’s structural vulnerabilities and imbalances pose a threat, especially in the medium to longer term. The New Silk Road initiative may allow China to expand investment opportunities and absorb part of its overcapacity, but the risk of a hard landing remains non-negligible. Meanwhile, growth in other EM countries is likely to pick up moderately now that cyclical factors such as low commodity prices and sluggish trade have run out of steam. India will remain the fastest growing economy in Asia, benefitting from its demographics and sheer size. Prospects for global commodity exporters, instead, look less favorable, especially those with direct exposure to China such as Indonesia and Latin America. Latin America will remain the only region with negative growth in 2016 with Argentina, Brazil and Venezuela all in recession.
This global outlook should lead to a gradual restoration of world trade to growth rates close to those of world GDP in the 3.5% range, a process we think could take two to three years, however.
The first divergence in monetary policy in many years between the world’s two biggest central banks should push the UST curve higher at a faster clip than what is presently priced in. It could well be spring or early summer 2016 before Bunds begin to reconnect to Treasuries, with the 10 year Bund yield reaching 0.75% by year-end. We expect core-periphery spreads to keep tightening in the medium term.
In credits and equities, we like risk. The recovery, which is stronger than generally expected, and a dovish ECB will lend measurable support to European equities and higher yielding credits.