As good as it gets

The global recovery has moved up a gear in the last year. The year 2018 is likely to be the best year for world growth in seven years. But this is a mature recovery and, at the risk of sounding like a kill joy, this is about the time you’d expect the economic cycle to start rolling over. For the rich western economies the second half of 2018 is likely to mark the peak in growth.

The US and UK economies have been growing for more than eight and half years. By the end of this month this will become the second longest American recovery in 150 years. Post war recoveries in the UK have, on average, run far longer than US recoveries, but this one is the third longest recovery since the War.

This may be an old recovery but, for Americans and Brits, it has failed to deliver the growth seen in previous upswings. For both countries this has been the weakest recovery since the War and growth in disposable incomes has been similarly lacklustre.

The story in the euro area is different. Its recovery is younger and, especially in the North, has delivered better income growth than in Britain or the US. The euro area upswing is likely to end up as the strongest since before the financial crisis.

Yet in the last month or so we’ve seen signs that the pace of growth is moving towards a peak. Michael Penn, Chief Economist at Cohen and Steers in New York, has picked up a softening of the upward momentum in global economic activity. Industrial output data have been lacklustre across the world. The change has been most marked in the euro area which has seen a string of disappointing economic activity releases in the last month. One of Europe’s most widely watched indicators, the German Ifo survey of business sentiment, has unexpectedly edged lower from January’s all-time peak. It looks like the pace of growth took a knock in the first quarter of this year in both the euro area and the UK.

This isn’t dramatic stuff and the economic outlook remains positive. Indeed last week the International Monetary Fund raised its global growth forecasts. Any drag on activity from severe weather and the flu outbreak in the first quarter should pass. It is possible that jitters about trade wars could prove transient.

But something else is going on. Markets and companies are having to contemplate a rolling back of the ultra-cheap money policies of the last 10 years. The Federal Reserve is expected to raise US rates by 100 basis points (bp) by the end of 2019, taking US interest rates to around 2.75%, the highest level since March 2008. Mark Carney, governor of the Bank of England, has dampened expectations of any sharp upward move on UK rates in recent days, but markets still expect the Bank to hike rates by 25bp in May. Economists expect the European Central Bank to end its programme of money-printing, or quantitative easing, in the second half of this year.

The steady rise in interest rates, or yields, on government debt since last summer shows that financial markets are factoring higher interest rates. Central banks want to ensure that, when it comes, monetary tightening is gradual and well signalled. They want to start the process of normalising monetary policy without derailing growth.

So the most likely outcome is that global growth next year will ease back only modestly. Still, the current run of softer data, the headwinds from trade jitters and the prospect of higher interest rates, are a timely reminder that recoveries do not last for ever.