Uncertainty around Syria, Russia and the United States-led trend towards more protectionist and confrontational trade policies is providing political headwinds for financial markets.
Nonetheless, we reaffirm our positive macro assessment. Protectionist policies will add to the reflation trend at the margin. The main driver for increasing inflation rates continues to be tighter labor markets and higher capacity utilization. Our policy rate and financial markets forecasts remain unchanged this month.
This month our internal discussions focused on whether increasing global geopolitical tensions and protectionism necessitate a downward adjustment of our positive macro scenario. In short, the answer is “no”.
However, they confirm our assessment that current economic policies in the US hardly increase its potential growth and add to inflationary pressures. Therefore, we are comfortable with our US GDP forecasts of 2.6 percent in 2018 and 2.1 percent in 2019, which remain 0.2 percent and 0.3 percent, respectively, below consensus.
Instead, we have increased our forecast for US inflation for 2019 to 2.4 percent since we see supply-side constraints as indicated by an increasing employment rate and capacity utilization. Higher import prices (3.6 percent year-on-year in March) and core producer prices (2.7 percent in March) will further add to cost pressures even if that only becomes visible in the CPI at a slower pace.
As a result, we feel comfortable with our forecast that the Fed will continue with quarterly rate hikes in the following 15 months.
We acknowledge that economic indicators – particularly in the euro area – largely surprised on the downside in the past month but consider this a technical reaction to unsustainable and exceptionally strong data in the winter months. This will likely result in weaker first-quarter GDP growth.
However, the medium-term prospects for economic growth in Europe have improved as the risks of a hard Brexit declined following the draft transition agreement between the European Union and the United Kingdom.
As a result, we have also increased our UK GDP forecasts for 2018 and 2019. We still expect that subdued real income developments will lead to weaker growth in the UK than in the euro area and Switzerland.
However, the Bank of England is likely to increase its base rate in May – hence, much earlier than the European Central Bank and the Swiss National Bank – as inflation remains significantly above target and a tight labor market leads to the risk of permanently higher inflation expectations.
Finally, we did not change our forecasts for the euro area, Switzerland and China, but adjusted our forecasts for Japan to reflect recently published data.
We have also decided to leave our financial market forecasts unchanged this month. This implies that we continue to expect government bond yields to increase from current levels and the spread between US dollar and euro bond yields to decline.
We consider the Swiss franc to be close to fair value and only expect a slight depreciation versus the euro. In line with lower growth prospects for the UK and the need to stimulate external demand for its products, we expect the British pound to depreciate further over the medium term.
For equity markets we remain cautious in the short term but confirm our index targets for the year-end remain 5 to 10 percent above current levels. We would favor emerging market over developed market equities.
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