Economic Research
June 30, 2017
Global Data Watch
We hold these truths to be self-evident ... for now
The global economy has delivered a year of above-trend growth and slack
continues to decline rapidly. The DM unemployment rate has dropped 0.4%-
pt over the past year. At 5.7%, this now aligns with the peak of the last expan-
sion (Figure 1). With confidence building that solid growth can be sustained
amid tight labor markets, it is no surprise that DM central banks are now pre-
paring markets for policy normalization. The Fed is signaling it is ready to
reduce its balance sheet alongside continued rate normalization. ECB gover-
nor Draghi was upbeat this week, hinting that policy settings may be tailored
to improving conditions. While we believe a weak UK consumer will stay the
BoE’s hand, the Bank’s recent communication is preparing markets for a pos-
sible rate hike. And strong Canadian activity readings—we revised up current
quarter GDP growth to an annualized 2.8% this week—has prompted the BoC
to signal that its first hike will come soon.
Behind this shift in rhetoric is central banks’ recognition that policy normalization
willbe material and challenging. Indeed, DM labor markets have returned to 2008
levels but policy rates are roughly 350bp below the previous peak (Figure 2). G-4
central bank balance sheets have, at the same time, expanded by close to 30%-pts
relative to GDP.The case for this extraordinary degree of accommodation could
until recently be explained largely by growth considerations. Aggressive policy
easing initially was required to counter deep recessions (two for the Euro area and
Japan). Persistent credit market headwinds related to reverberations from the fi-
nancial and sovereign crises have also been a factor (see the research note “Credit
growth slows, reinforcing already tame cycle” in this GDW).Weak supply side
performance that lowers equilibrium interest rates also played a role. And since
2014, central banks have been sensitive to risks related to weakness in EM de-
mand and commodity sector output. If we are right, DM growth will remain solid
and EM and commodity market tail risk will continue to abate. A full policy nor-
malization consistent with current conditions would require (after accounting for a
percentage-point decline in DM equilibrium policy rates) at least 200bp of tight-
ening, alongside a material balance sheet unwind. Given central bank forecasts,
the size of this adjustment will grow.68
90.8
1.0
1.2
1.4
1.6
1.8
2.0
0305070911131517
%oya
Figure 1: DM core CPI and U-rate
%, sa
Source: J.
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