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Global economic growth likely to improve in 2017

We believe global growth will improve in 2017 from 2016, but risks will remain. And the picture is becoming more complicated. During the last two years, global economic growth has been at the weakest levels since the global financial crisis that began in 2008. This slow growth has been driven by several things that we have discussed in the past, including lower oil prices and a stronger dollar.

The key drivers of slow economic growth prompted global weakness in manufacturing, capital spending and international trade, as well as bloated inventories. We believe that some of these headwinds are beginning to ease and may send global economic growth back to levels seen in 2012–14.

The U.S. economy was disappointing in 2016. Capital spending was weak as oil-related investment contracted and global uncertainty resulted in little appetite to expand manufacturing capacity. Inventories were a major drag on growth as industrials and other sectors saw an unwanted buildup in stockpiles. Only consumer spending held up well this year, supported by continued growth in employment and low inflation.

We believe that growth is primed to bounce back in 2017. The rebound in oil prices is likely to eliminate the severe decline in oil-related investment that took place in the last two years. In addition, we believe that inventory levels are much more closely aligned to sales and expect that drag to fade. We think there will be better economic growth in the rest of the world, resulting in better export growth in 2017.

We think employment growth will slow as it becomes more difficult to find qualified workers. This slowing is likely to continue to put upward pressure on wages. We believe income growth should continue to be well supported. However, we expect both higher gasoline prices and the increasing burden from health care costs to squeeze the purchasing power of consumers. We believe that consumer spending will be a bit softer in 2017 versus 2016. Overall, we forecast average growth in U.S. gross domestic product (GDP) to be around 2.5% in 2017.Under this scenario, we expect the Federal Reserve (Fed) to hike rates once in late 2016 and twice in 2017.

Economic growth in Europe continues to be mixed. Germany continued to perform relatively well on the back of consumer spending and construction. Further healing in Spain also resulted in a strong contribution to eurozone GDP growth. In France, terrorist attacks earlier in the year resulted in a pause in the recovery, although the economy looks to be gradually improving. Italian GDP growth continues to lag. While reforms by Prime Minister Matteo Renzi are a positive, recent political and banking uncertainty is proving disruptive to the economy.

Looking to 2017, in general we expect consumption throughout the eurozone to continue at a healthy pace. Export growth is forecast to improve along with better global economic growth. While actions by the European Central Bank (ECB) continued to bring about improvement in bank lending in places like Italy and Spain, we worry that renewed concerns about banks in Italy and Germany could delay further improvement.

Japanese economic growth was little changed in 2016. The continued drag from a declining population and a weak global economy prevented much improvement. Looking into 2017, we expect growth to improve on the back of government stimulus and export growth. We forecast GDP growth of around 1.0% in 2017. In September, the Bank of Japan (BOJ) announced a change to its monetary policy framework by targeting the 10-year government bond yield “around zero” and abandoned its official QE target. We believe that the BOJ will maintain its pace of QE for the time being in an effort to allay fears of tapering the pace of purchases.

While we are positive on the global economy in 2017, we believe that the risks to our outlook are growing. In addition, we worry about geopolitical events. The increasingly negative rhetoric between the U.S. and Russia gives us some concern, as does China’s activity in the South China Sea. Further increases in terrorism in the western world could bring about a slowdown in economic activity because of fear and uncertainty.

From a macro perspective, we believe there are risks related to global monetary policy if it suddenly reacts to rising inflation and tightens more aggressively than expected. While we believe the probability is low, it is not zero. The recent increase in the price of oil and other commodities also has been a positive for the global economy. If prices rise significantly more in 2017, then we would carefully watch for evidence of demand destruction in the global economy and weaker economic growth.

Source: Ivy Investments

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