Business

Hamish McRae: Scary world of deficits, strain and pain

Bank of England: Governor Mark Carney is due to report on inflation
AFP/Getty Images
Hamish McRae
30 July 2019

This is a big week for the world economy.

The biggest news comes on Wednesday when the US Federal Reserve cuts interest rates for the first time for more than 10 years.

The only questions are whether it will be a quarter-point cut or a half-point, and what chair Jay Powell signals about future moves.

Also tomorrow we’ll learn how bad the second quarter has been for the eurozone with the latest GDP figures. Have things really got “worse and worse”, as Mario Draghi, president of the European Central Bank, said last week? And what is worse and worse: slow growth or none at all?

On Thursday we’ll learn how hard the Bank of England thinks the UK economy is being — and will be — hit by Brexit, when it produces its Inflation Report.

And of course we will want a feel for Governor Mark Carney’s call on the issue of the hour, the growing likelihood of no-deal.

This all takes place against a background of trade talks in Shanghai between the US and China. What should we make of all this?

As far as the China trade talks are concerned this is the first high-level meeting since May, when talks broke down. Provided we have low expectations we won’t be disappointed.

The key issue here is to what extent the present trade spat is the main reason for the global slowdown, and to what extent there would be a slowdown anyway.

As far as Europe is concerned, weak exports to China have hit the German economy, but that is only partly due to US-China tensions. It is because Chinese demand has slowed more generally. It is the world’s largest car market, and sales were down 14% in the first half of this year.

As for the rest of the eurozone it would be wise to have low expectations there too. We will have to wait until September to see what the ECB does to try to push up growth.

The US economy gets its boost now. But does it need lower interest rates when it is already getting a massive push from fiscal policy? The US budget deficit is 4.2% of GDP and that is when the economy must be close to full capacity.

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This is scary. After all, we are wondering whether our deficit could be allowed to rise from a bit over 1% of GDP to perhaps 2%. The US can get away with borrowing more than any other country, given the ubiquitous role of the dollar in the world economy, but this is pushing it.

Meanwhile we’re in a holding pattern. If there is no Brexit deal, sterling will take the strain — as it is already doing. Thanks in part to that, the Footsie is within a whisker of its all-time high.

Andy Haldane, the Bank of England’s chief economist, warned us last week not to count on the Bank cutting rates and we should take that warning seriously. He probably has a better feeling than anyone else both for the current slowdown and the impact of a hard Brexit. If he is really worried, then we all should be too.