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We are now on recession watch

A series of global events have conflated and will result in a hit to world economic growth this year. It has raised the possibility of a recession in some countries.

A series of global events have conflated and will result in a hit to world economic growth this year. It has raised the possibility of a recession in some countries.

by
John Redwood

in Features

20.02.2020

It takes almost a month at sea to carry goods from central China to the UK. The total journey time from a Chinese factory to a UK shop or assembler may be closer to six weeks.

We are currently living off Chinese supplies despatched before the Chinese New Year shut down and before much disruption to Chinese manufacturers by the virus. The official new year holiday ran from 25 January to 8 February. Next month, we will start to see the impact of the extended Chinese New Year closures and the continuing interruptions to supply from only partial returns to work.

Some employees are stranded away from their factories, some are self-isolating following contact with virus victims, and some factories remain closed because they are located in virus hotspots. Apple warned us early of lost sales in the first quarter of 2020 as a result. It will not be the only company suffering.

Last year we were sure the world economy would continue growing at a modest pace. We forecast a manufacturing downturn, led by vehicles, which duly unfolded. The twin motors of the US and China stayed well within positive growth territory, whilst the EU and Japan avoided an overall recession, as we expected. The bond markets signalled a recession by putting the long-term rate of interest below the short-term rate for some of the time. This reflected the massive injections of liquidity and the continued central bank buying of Treasury bills and bonds to keep short rates down, more than being a reliable indicator of recession.

Conflating factors

In the early months of 2020 the slowdown has worsened, and the short-term outlook for growth has deteriorated. It is a range of problems coming together that has made the world economy look more vulnerable.

In the US, Boeing has halted production of its most popular plane, the 737 Max, which accounted for the biggest share of its output. Boeing was producing about 1% of US GDP, so the US economy could suffer a hit of around 0.5% (annualised) overall from Boeing’s difficulties. From the moment the world learned of the crash of a Lion Air 737 in October 2018, Boeing has been wrestling with the systems and airworthiness of this crucial plane. The crash of the Ethiopian 737 in March 2019 confirmed problems. It led to the grounding of all 737 Max aircraft, and delays to delivering the many new ones on order. We still have no firm date for likely regulatory approval of the revised 737 Max, nor therefore when production can be resumed.

The arrival of the coronavirus has done substantial damage to the Chinese economy. There is, as yet, no official new forecast, but it seems likely that at least in the first quarter of 2020 there will be a substantial hit to economic output.

The virus has knock-on effects around the world. Tourism and travel will be well down, with many cancelled flights to and from Asian destinations. The cruise industry has received plenty of unwelcome publicity thanks to ships being used as isolation units or finding it difficult to locate a harbour that welcomes them once they have a health case onboard. Takings from Chinese tourists are well down in many locations as they stay at home. Supply chains will be affected by shortages of Chinese output of important components. Outside China, the creeping presence of the virus is reducing demand for events and conferences for fear of contagion.

Auto slowdown

The car industry remains at the centre of the world downturn. Various governments have increased taxes on conventional diesel and petrol cars for environmental reasons. Some governments have also threatened future bans on use or purchase of vehicles with carbon dioxide emissions. China imposed a new car tax of 10% which led to a sales fall. France and Sweden launched tougher tax regimes for higher carbon dioxide emission vehicles from this January. Italy, Spain and the UK amongst others have tax regimes that penalise higher emissions. This has led to a big fall in diesel car sales in many places.

US car sales have also been weak. In January, with the advent of new higher taxes, EU car sales fell 7.5% led by France with a fall of 13.4% thanks to tax rises. There had been strong sales last December ahead of these tax rises. The consumer is not yet ready to buy electric cars in sufficient numbers to compensate though, where incentives are offered, electric car sales are accelerating rapidly on a very low base. In some cases, such as China and the Netherlands, the government is reducing electric car incentives as sales increase. All governments will have a substantial revenue problem if electric car sales take off as they wish to imply the need to alter tax and subsidy arrangements at some point.

Japan decided to go ahead with the imposition of a higher sales tax late last year. This has led to a sharp fall in output, exacerbated now by the coronavirus, the damage to world trade and the policy impacts on the car industry. The Japanese economy contracted at an annual rate of 6.3% in the final quarter of last year and remains weak in 2020 thanks to these wider developments. Germany last year narrowly missed a recession, as defined as two down quarters, but recorded very little growth. The latest ZEW figures imply conditions have worsened this year after the beginnings of a recovery late in 2019.

Energy slump

The virus and its effects on Chinese industry and world trade has helped power a 20% fall in the oil price, with knock-on effects to the oil and gas industry and to investments in that activity. The whole fossil-fuel-based sector is also under structural pressures to slim down and to transform into renewable energy, which will impose big costs from the transition.

Governments and central banks are not willing to accept a general recession. The main central banks of Japan, China, the US and the Euro-area are all taking monetary and credit action to keep markets liquid, pumping cash into economies to prevent an actual fall in output. The US government has undertaken a big fiscal expansion, and others including the UK, China and Japan are moving in the same direction. China has started a series of small steps to reduce interest rates and offered cheaper credit to companies producing essentials in difficult conditions.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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