Abe,known asAbenomics, are along the right
lines. But the authorities have not been
determined enough in the fight against
deflation.To find its way out of the deflationary
trap in which it seems to be, and to overcome
its huge fiscal imbalances, Japan needs several
years of quite high inflation – 4%, 5% or even
6% – combined with continued low interest
rates.That means that the yen needs to be
forced lower and quantitative easing needs to be
expanded to a level not yet envisaged.Without
that,we are likely to see more of the same.
By contrast, I am pretty confident about the
US.There are occasional weaker months, but
job creation is generally sound and the
recovery is deep-seated. I do not see what
could send it off course.A stronger dollar is a
concern but the US is still much less involved
in international trade than other countries.
The eurozone remains one of the main
reasons for weakness in the global economy.
Admittedly, it has recently got a bit better:
Ireland has been enjoying reasonable growth
and Spain seems to be digging its way out of
the mire. But overall growth is very weak.The
problems remain acute in Greece and chronic
in Italy; France remains unreformed and there
is little prospect of that changing.
There is also growing uncertainty over
Europe’s political future. Elections in France
and Germany are on the horizon.Mass migration poses a major
political challenge for Europe, whileAngela Merkel’s suggestion of
accelerated EUmembership forTurkey has not been well received.
Across the Continent there is increasing euro-scepticism; and if the UK
leaves the EU, that could further inflame sentiment.
The prospect of a break-up of the euro has, on the face of it,
gone away but that is just superficial.This is a rolling crisis that
comes and goes. Greece’s deal with its creditors was predicated on
two conditions: passing and enacting economic reforms, and
returning its budget deficit to acceptable levels.The key question
is what will happen if and when Greece fails to meet these
promises and needs more money.What will the lenders do?
This brings me to the UK. One of the key issues facing the economy
here is fiscal tightening (ie, increases in taxes
and reductions in public spending).The
government eased off before the election but
tightening is now resuming and that will be a
restraining factor for the economy in the year
ahead.Mind you, real wages, which were
falling not that long ago, are rising again and
that should continue to help the economy
withstand the impact of the fiscal squeeze.
Employment growth should continue to be
reasonably good and I expect unemployment
to edge down, although not as much as
previously. I am, however, worried by the
increase in wage costs implied by the
introduction of the National LivingWage,
which I think will cause job losses in the
hospitality and retail sectors. I think bosses
will not allow wage increases at the bottom
to reduce differentials between employees.
So there will be a more general increase
in wage costs, leading to job losses.
Nevertheless, I am more than hopeful that
the economy will be strong enough to
withstand this.
I have long been a dove on interest rates.
Just after the financial crisis, I predicted that
interest rates would stay at their record low
for five years.Most commentators thought
that I was wrong, but more than six years on,
we are still there. But not for long. I think
there will be an increase in 2016, although no
one can predict exactly when. I get the sense
that policymakers are anxious to get on with
the job of normalising rates, albeit gradually.
Inflation will obviously increase sharply in
2016 but this should not cause alarm. It has
fallen to zero, and in some months just below,
because of the drop in oil and other commodity
prices.As this falls out of the annual comparison,
we will see an increase in inflation towards the
target rate.The Bank of England may then get anxious that this will
increase inflation expectations and result in higher wages. But I am
quite confident that inflation here will not be racing back to troubling
levels for a good many years yet.
Economists are not – and should not try to be – market tipsters.
What they can do is point to situations where asset classes look to be
valued fairly – or not – in relation to long-running economic
fundamentals.Among investment classes, bonds currently look to me
to be extremely expensive. I do not know when that will change, and
they could be fine for the next year or so. But over the medium term,
there is no doubt about the direction bonds will take: you don’t want to
be holding the parcel when the music stops.
Large-cap UK equities, on the other hand, look better.Although
their yields and outlook are not exactly
exciting, they offer reasonable value. I would
be surprised if they did not give a decent
return over the medium to long term.
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THE INVESTOR
It is impossible to say how successful the policy
of quantitative easing (QE), often referred to
colloquially as ‘printing money’, has been in
promoting economic recovery, as we do not
know what would have happened without it.
That said, I think that QE was vital in sustaining
confidence when the crisis erupted.There were
points in 2008/09 when it seemed that there
was nothing policymakers could do. By using QE
to pump in liquidity, the markets were reassured
that some action was being taken. So, in that
respect it might have saved us from a fate akin
to the 1930s – or even worse.
But I do not think that QE has been massively
significant recently. I do not even think it has
had a particularly big impact on asset prices.
There has been an impact on bonds to a certain
extent; but most of the depression of bond yields,
I think, has been the result of the extended
policy of very low short-term interest rates, and
of regulatory policy that has pushed funds
towards holding bonds rather than equities.
Many people find the idea surprising that QE
hasn’t had, and won’t have, a dramatic
inflationary effect. But in an economy recovering
from a financial crisis, the financial system
does not work properly and so financial stimuli,
including QE, do not work properly either.
When the time is right, QE can be reversed.
Balance sheet
Although UK inflation will rise in 2016,
this will not present a problem. Interest rates will rise
gradually from this year. Bonds are very expensive.
Getty Images
ECONOMIC
OUTLOOK
The eurozone remains
one of themain reasons
forweakness in the
global economy
HAS QEWORKED?
ANALYSIS
ECONOMY
