Economic forecasting is a mug’s game. One thing learned from the financial crisis and Great Recession is that even those equipped with the most sophisticated models get it wrong, sometimes spectacularly. So it is with both humility and trepidation that I will try to make predictions for what is going to happen in 2016. In all honesty, the future is unknowable and anybody who says otherwise is lying. So, with that caveat, here’s what I think might happen. At some point, a recovery built on booming asset prices, weak growth in earnings and rising personal debt is going to lead to another huge financial crisis – but not in the next 12 months. Instead, 2016 will be a year of living dangerously, papering over cracks and buying time before all the old problems resurface.
Here’s why. The big story of the past month has been the collapse in oil prices, which has taken the price of crude back to levels last seen in 2004. This has two beneficial effects for the global economy. It provides additional spending power for households and businesses that consume energy, and it bears down on inflation. There is always a bit of a delay between oil prices falling and spending going up, in part because people want to be sure that the lower costs are going to stick. It is, however, now 16 months since crude began its decline from its August 2014 peak of $115 a barrel, and there is a good chance it will fall a bit further from its current level in the mid-$30 a barrel range. With no sign that the oil cartel, OPEC, has the political will to agree production curbs, it is quite possible that prices could fall below $30 a barrel in the early months of the year.
The impact of that will be to keep inflation lower than any of the world’s major central banks are anticipating. Policymakers at the US Federal Reserve, the Bank of England and the European Central Bank (ECB) insist they “look through” rises and falls in oil and other commodity prices and make their interest rate judgments on the basis of what is happening to core inflation, which excludes energy and food costs.
But it is harder to raise interest rates if, for whatever reason, inflation continues to undershoot official forecasts. More importantly, there is evidence that a fall in inflation caused by cheaper oil has an effect on wage bargaining. When, in the pre-crisis years, UK inflation regularly hit the government’s 2% target, employers used to offer pay awards of 4%. Now that inflation is zero they see no reason to offer more than 2%. That matters because central banks are looking for signs of wage inflation picking up as a result of years of steady growth and falling unemployment. If wage inflation does not go up, there is less of a reason to raise the cost of borrowing.
So prediction number one for next year is that both inflation and interest rates will stay lower for longer than currently anticipated. The Fed raised interest rates for the first time in almost a decade earlier this month, but will be extremely cautious about its next move. The Bank of England will hold off from its first move. Cheap money will boost both borrowing and – for a time – growth. In China in 2016 the question is not whether the pace of growth will slacken, but by how much. Expert opinion differs about the state of the world’s second biggest economy. Some analysts say Beijing has everything under control, others that the country isalready having a hard landing from years of over-investment in unproductive manufacturing plant and speculative real estate. It is hard to know exactly what is happening in China, a big country with a reputation for unreliable economic statistics. Official data says the economy is growing by 7% a year, yet data for electricity consumption and rail freight suggest the actual figure is lower.
Whereas official interest rates are zero or thereabouts in the major developed countries of the west, in China they are still above 4%. This gives the People’s Bank of China scope to cut the cost of borrowing if it wants to stimulate growth, a scope it will almost certainly use if the government thinks the economy is slowing too rapidly. The exchange rate can also be cut to make Chinese exports cheaper, and the country also has the option of raising public spending. The risk, of course, is that China cleans up the mess caused by one collapsing bubble by inflating another, which is what Alan Greenspan did in the US in the early 2000s. Here, then, is a second prediction. China will slow in 2016 but policy easing will prevent a collapse.
Over the past six years, the Eurozone has shown an unerring ability to snatch defeat from the jaws of victory. Every time the crisis has appeared to be over, something nasty has happened. In 2016, that “something” could be Greece, caught in a debt and austerity trap, it could be rudderless Spain or moribund France. There are a couple of reasons, however, why the Eurozone might stumble through to 2017 before there is fresh trouble. The first is that it will benefit from the delay in tightening policy in the US and the UK, and from pro-growth measures in China. The second is that the ECB will keep using quantitative easing in the hope that an increase in the supply of money will get the banks lending. The ECB is also keen to drive down the value of the euro to boost exports but this may prove more difficult if the Fed raises interest rates more slowly than the markets currently expect. There is a good chance the dollar will fall rather than rise against the euro.
The biggest immediate risk to the global economy comes from the emerging world, especially parts affected by the crash in the cost of commodities. Brazil is the country to watch out for. It is the biggest economy in Latin America and in serious trouble. The economy is contracting at its fastest rate since the 1930s, inflation is above 10%, the currency has collapsed and the finance minister has just resigned. A visit from the IMF may be unavoidable. This is a case of history threatening to repeat itself, because the buildup to the 2008 crisis began on the periphery of the global economy. So, here is my final prediction: there will be no explosion in 2016, but a fuse will be lit.
By Larry Elliott