Doubts about growth, but no real worries

You missed me for a few weeks. Not only did I go on holiday, I also got a new hip and am now rehabilitating. Every day a little better, but still with trial and error – figuratively speaking…

It actually works the same way in economics. The first half of the year was mainly dominated by optimism, driven by the vaccination process and the reopening of the economy. As a result, forecasts for economic growth were continuously and on balance sharply revised upwards. So it was all 'getting up' and little 'falling'.

The picture is now changing. Despite ongoing vaccination programs, the number of infections has risen sharply in many countries recently. This has not yet translated into a corresponding increase in the number of hospital admissions or IC occupancy, but the question is whether the restrictions on public life will be tightened again and how consumers will respond to all this. Last year it was often argued that it was not the lockdown measures but people's fear of getting sick that limited consumer spending. That may have changed by now, but with the delta variant on the rise, the risks are on the downside.

Higher inflation hampers growth
Then there are a few other things that could negatively affect economic growth in the short term. Inflation has risen sharply, especially in the US (and to a lesser extent in the US). Central bankers are shouting in unison that the higher inflation is temporary and the financial markets seem to agree, as evidenced by capital market interest rates that have fallen significantly again in recent weeks. Regardless of whether the higher inflation is temporary or not, purchasing power is directly affected and that puts a damper on economic growth. There is no other way.

As mentioned, inflation in the US has risen much more than in the United States. In June, US inflation was 5,4%. That cuts into purchasing power. The Atlanta Fed calculates the economic growth in the current quarter on the basis of macro figures that are available daily. Such a metric is known as 'nowcast' (to distinguish it from 'forecast') and the Atlanta Fed calls its own metric 'GDPNow'. The green line in the chart below shows the trend for the second quarter from the beginning of May. The highest estimate for economic growth in the second quarter was 13,7% (that is the annualized growth compared to the first quarter), but that has now fallen to 7,6%. In the course of the second quarter, the pace of economic growth has therefore slowed down considerably by this measure. The blue line is the average of a large number of private sector forecasters. If the Atlanta Fed is right, the majority of economists will be disappointed when the growth figure is released.

Industryële activity muted
Logistical disruptions are another growth impeding factor. Last year, global activity and international trade collapsed quite a bit. The recovery in demand for goods returned faster and more vigorously than expected. The logistics world and the production side are having great difficulty keeping up. We have been talking about the logistical problems and disruptions of supply chains for three quarters of a year now. Macro-economists are usually light-hearted about this, like 'it will sort itself out'. The problems are now somewhat persistent. As long as they continue, they will put a damper on the recovery.

I have written in the past about the growing gap in Germany between factory orders and actual production. That gap is now unimaginably large. Now it is wonderful that order books are well filled, but if production is not possible, this does not contribute to economic growth. And who continues to place orders if there is no delivery? Production in the manufacturing industry in Germany was 2,3% lower(!) in May than in December 2020. The American industry is struggling with similar problems. Manufacturing production there was only 1,1 higher in June than in December 2020. The fact that the German figures are worse than the US is due to the problems in the automotive sector, which has a greater weight in Germany than in the US.

Recovery mainly comes from the service sector

Now I should immediately point out that industry is only a small part of the modern economy. The pandemic has hit the services sector at an unprecedented rate and the normalization of public life is particularly boosting that sector. Preliminary business confidence figures for July as compiled by IHS Markit still paint a very positive picture for Germany, as the following chart shows.

The business confidence index in the German services sector reached its highest point since June 1997 in July. Industry entrepreneurs also remain very optimistic, despite supply problems: 65,6 in July against 65,1 in June. Perhaps unnecessarily, anything above 50 implies growth. With regard to actual production, entrepreneurs were slightly less positive in July than in June: 63,0 versus 65,2. I think that 63,0 is a remarkably high position in view of the hard figures of the actual production.

China
A final factor sometimes pointed out in the context of global growth is China's development. In fact, that country has led the way in recent years and was also the first to be hit by the pandemic, after which the country's economy also recovered first. Meanwhile, the economic recovery in China seems to be losing some momentum. A few weeks ago, the central bank cut reserve requirements for banks somewhat, apparently in an attempt to boost lending. The latest figures certainly did not disappoint.

On balance, I think the upward revisions to growth forecasts have come to an end for the time being. In fact, it could very well be that in the coming months we will go a bit in the other direction. That is not alarming. The global economy has enough momentum to continue to grow at a decent rate and the factors that dampen growth somewhat in the near term will most likely prove to be temporary. Particularly in our kind of countries, where industry only forms a small part of the economy, the recovery in the services sector will dominate. At least… as long as we don't go into lockdown again.

ECB adjusts forward guidance
A few weeks ago, the ECB reformulated its policy strategy. According to the treaty on which the ECB is based, its main task is to achieve and maintain price stability. What exactly that is is described in the policy strategy. From 2003 it was stated that the ECB was aiming for inflation of below but close to 2% in the medium term. This strategy has therefore recently been reformulated. The ECB now has a symmetrical target of 2% over the medium term. Under the old strategy, inflation above 2% was found to be more harmful than inflation below 2%. Now that is no longer the case. Since inflation has been lower than 2% for a long time, all this does not mean much. Several years ago, some economists argued in favor of raising central banks' inflation target. The idea was that such an increase might raise people's inflation expectations and prevent deflation. The ECB now appears to have taken a very small step in that direction.

Last week, the ECB's policy committee decided to leave interest rates and the buying policy unchanged, but the forward guidance was changed. According to ECB President Lagarde, there was unanimous agreement within the committee that this forward guidance had to be adjusted because the strategy has been reformulated. But she also said that there was no unanimity about the new wording of that forward guidance. Through Lagarde, the ECB expects to keep interest rates at current or even lower levels at least until inflation of 2% is expected midway through the prevailing forecast period. And then the expectation must also be that such inflation is not just temporary. In practice, this will mean that the ECB will keep official interest rates very low for a long time to come. Lagarde did her best to explain that the ECB is not looking for such a 'lower for longer'. She argued that the purpose of the adjusted forward guidance is to give inflation expectations a boost, which means that an increase in inflation would come sooner. I didn't find it all that convincing.

It was not entirely surprising that journalists asked whether the adjusted policy strategy was not actually a reason to step up a gear with regard to the incentive policy. After all, the inflation target is further out of sight than under the old strategy. However, Lagarde did not want to go that far. Good thing, too.

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

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