Strategy: Capex set to add support to global recovery
|Investment growth has been the weak link in the global economy over the past three years. While private consumption was underpinned by robust real income growth - partly due to very low inflation - investments have been depressed. Political uncertainty, frequent shocks to the economy and depressed energy investments following the oil price collapse in 2014 kept corporate spending in check.
However, the scope for strengthening capital expenditure (capex) has increasingly been raised as a force that could make the global recovery more robust and resilient. Central banks such as the ECB and the Bank of England have also highlighted that stronger investment growth could increase the neutral rate for monetary policy and warrant higher rates in the future just to keep the policy stance unchanged.
In his speech in Sintra in June, ECB president Mario Draghi said: ‘There is newfound confidence in the reform process, and newfound support for European cohesion, which could help unleash pent-up demand and investment... As the economy continues to recover, a constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments – not in order to tighten the policy stance, but to keep it broadly unchanged.' The Bank of England governor Mark Carney similarly said that ‘If these [investment] intentions are realised, the global equilibrium interest rate could rise somewhat, making a given policy setting more accommodative.'
Below we look at the scope for capex growth to enter a self-reinforcing cycle that strengthens the global recovery. Recent developments do indeed give rise for cautious optimism when it comes to investments. Some of the important drivers for investment growth have proven to be business sentiment, profit growth, financing costs and potential pent-up demand for investments following a period of depressed investments. Some of these factors are clearly correlated as stronger profit growth tends to lift business optimism. But low financing costs for example may become more stimulative if optimism is high and may not be enough to trigger investments if the outlook is uncertain and demand is weak. Hence, it could very well be that the positive effect of low yields and rates strengthens as the recovery takes hold.
Going through the above factors does indeed point to a more positive picture for investments:
First, business confidence in the OECD area is now the highest since 2011. As the global economy has gained steam companies have grown more optimistic. Reduced political uncertainty has probably added to the more upbeat expectations among companies in continental Europe. While Donald Trump has disappointed when it comes to the outlook for tax cuts and reduced regulation, corporate optimism is still quite high. In the Philadelphia Fed survey the index for capex expectations is now the highest in close to 30 years.
Second, profit growth picked up in late 2016 and early 2017 as the global economy gained steam and rising producer prices benefited the bottom line in many companies. When companies make money they are naturally more inclined to invest than when profits are falling.
Third, financing costs are historically low. In the euro area five-year corporate real yields are around zero (using core inflation as deflator) and in the US it is just around 1%. The average prior to the financial crisis was around 31/2%.
Fourth, there may very well be pent-up demand on the investment side. Investments as a share of GDP are still below the average prior to the financial crisis. This is most pronounced in the euro area. As the outlook improves and uncertainty declines some of this pent-up demand may come through.
The rising potential for a self-reinforcing cycle in investments poses some upside risks to our growth outlook for the coming years. And if it materialises it will put upward pressure on bond yields as demand for capital increases and central bank policy normalisation may happen faster.
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