This will keep the global economy busy in the new year

At the beginning of the year, economists, analysts and commentators give their views on what this year has in store for us. Perhaps you are worn down by this flood of opinions. At the risk of you clicking away right now, I will also add my two cents.

In 2024, the global economy has diverged considerably. The US economy grew faster than expected, while growth elsewhere was disappointing. And expectations for Europe in particular were not very high.

Now I read all kinds of stories that Europe might actually do better this year. That seems to me to be largely 'wishful thinking'. I’m sticking with a muddling through scenario for Europe. Sure, lower inflation and improved purchasing power will lead to somewhat stronger growth in consumer spending, but Europe continues to struggle with a number of issues. The gas price is one of them. It hasn’t gotten any better in the course of 2024. Currently, the European gas price is more than four times as high as in the US.

Partly because of this, but also because of our industrial structure and excessive regulation, the process of deindustrialization in Europe continues. If the new American president carries out his threat to introduce and increase trade tariffs, it will be a new blow. Not only will it harm our exports, but, perhaps more importantly, Chinese producers will try to offer the goods they can no longer sell in the US on the European markets, possibly at dumping prices. What that country is capable of - even without dumping prices - is illustrated by the following picture.

Global car production is around 95 million units. While total production in Germany has fallen from almost six million units per year in 2015-2018 to around four million now, the Chinese have managed to increase their exports from less than one million before the pandemic to almost five and a half million now. You don't want to extend these lines.

Furthermore, several European countries are struggling with significant budget deficits and there is no room for expansionary budgetary policy. In this situation, the ECB will undoubtedly lower interest rates further, but this will not lead to more than modest economic growth this year.

Perhaps the pressure on Europe will become so great that sufficient reforms will finally be implemented to structurally boost growth dynamics.

Chinese challenges
The Chinese economy also faces challenges. The growth model that has dramatically increased prosperity over the past 25 years and lifted a huge number of people out of poverty is broken. That model was based on investing in infrastructure and housing, as well as increasing exports. However, the real estate sector is in crisis and local governments have high debts, making investment in infrastructure difficult. The threat of new and higher import tariffs in the US is worsening the outlook for exports.

China has been trying for several years to generate more growth through stronger growth in domestic consumption, but due to a lack of a good social safety net and the real estate crisis, this has not been very successful so far.

The development of the capital market interest rate in China is probably significant. Especially in the last few months, it has taken a nosedive. That is undoubtedly not a sign of economic prosperity.

In the past, the Chinese government has regularly given the economy strong impulses with stimulus policies. They are trying to do the same now, but apparently with the handbrake on. It is quite possible that further stimulus programs will be started this year. Then growth could surprise positively, but 'don't hold your breath'.

America under Trump and Musk
A few months ago I wrote that a recession in the US was probably inevitable, but that it would be mild, short-lived and would do little damage to the stock markets. That recession has not (yet?) come. As is often the case, the resilience of the US economy has surprised us.

That is not to say that there are no weak spots in the US economy. Consumers have kept the economy going well in recent years, but may have overestimated their own financial capabilities. As a result, the number of defaults on loans has been rising for some time. It is difficult to say to what extent this will harm growth in the future. 

The housing market, normally a source of dynamism, is also failing considerably. Although interest rates have fallen in 2024, they are still much higher than a few years ago. Nevertheless, house prices have risen. This combination leads to a decrease in the affordability of homes, which has an impact on the number of transactions.

That US economic growth exceeded expectations last year is also due to the fiscal policy under President Biden, which has been generous from the start of his term. As a result, the budget deficit has remained at a high level, around 6% of GDP.

With the new president in office, economic policy will also change. On balance, the Trump-Musk duo will implement a pro-growth policy, including tax cuts, far-reaching deregulation and free rein for the exploration and exploitation of fossil fuels. Entrepreneurs in the SME sector drew so much optimism from the election results in November that the confidence index of their interest group, the NFIB, shot up.

Whether the optimism among SMEs is justified, we will see. The uncertainties are considerable. The possible import tariffs could give inflation a new boost. Another major uncertainty is how successful Elon Musk will be in making the government apparatus more efficient. In any case, it is interesting to see how a tough and extremely successful businessman will fare in that role. For Trump, a lot depends on that because the savings that Musk manages to realize will be necessary to prevent government finances from getting further out of hand. If the anticipated savings are not realized and the federal deficits increase, the bond market could enforce budgetary discipline through a rising capital market interest rate. Then economic growth would take a hit. However, that seems to me more of a risk than the base scenario.

On balance, I think the US economy will once again achieve a nice growth figure this year, driven by the new policy. Don't forget that the US economy is leading in AI and that activity in that area will increase significantly.

Inflation and monetary policy
I will be brief about inflation. It has fallen sharply, but in most places it is still higher than central banks would like. The outlook is positive. Of course, unexpected shocks can throw a spanner in the works, but inflation will continue to fall on balance in 2025. This brings the realisation of the inflation target within reach for central banks.

Because the European economy is weaker than the American economy, it is reasonable that our inflation will reach the desired level sooner than in the US. The influence of possible import tariffs on American inflation is uncertain. It is clear that the rent increase that is important for American inflation will gradually decrease. This offers the prospect that the general inflation will also decrease further.

As the level of official interest rates in Europe and the US can still be characterised as restrictive, central banks will continue to cut their rates. In the case of the ECB, this will probably happen at a fairly rapid pace and I expect the deposit rate to be cut to below 2,0%. The members of the Fed's policy committee expect a majority of only two rate cuts this year. I suspect there will be more.

Bond markets
Capital market interest rates are influenced by opposing forces. Large government deficits threaten to put upward pressure on capital market interest rates. On the other hand, falling inflation and interest rate cuts by central banks will actually depress capital market interest rates. Ultimately, I think that the downward forces will be stronger than the upward forces, but the scope for a decline in capital market interest rates is limited.

Although European capital market interest rates are lower than US rates, the prospects for a fall in capital market interest rates in Europe are better than in the US due to the difference in cyclical prospects and the US budgetary position. The dollar may be expected to strengthen against the euro as a result.

Stock markets
Equity markets have had a very good year. 2023 was also a good year for equities. Just as the US economy outperformed the European economy, returns on US equities have been significantly higher than on European ones.

The combination of continued growth and lower interest rates is in principle a favourable combination for the stock markets. But it can be argued that this has already been discounted. Valuations are historically on the high side. There is also concern about 'concentration'. Especially in the US, a small number of large tech companies now make up a significant part of the various indices and have contributed disproportionately to the recorded price gains. On the other hand, these companies also achieved impressive profit growth.

A possible trade war and rising geopolitical tensions could lead to negative shocks. However, I expect equity markets to continue to generate positive returns in 2025, above the historical average.

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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