Euroland domestic demand slowed during the second half of 2017, with strong GDP expansion sustained by a rise in net exports, reflecting global economic buoyancy. Monetary trends suggest that domestic demand will remain subdued in 2018, while global cooling and euro appreciation may drag on trade performance. The consensus assessment of economic prospects may be overly positive.

Revised figures released today confirm an earlier estimate that GDP grew by 1.3%, or 2.6% at an annualised rate, during the second half of 2017 (i.e. between the second and fourth quarters). The “news” was in the expenditure breakdown: domestic final demand rose by only 0.6%, while a rise in net exports contributed 0.9 of a percentage point to GDP expansion. Total domestic demand grew by just 0.4% as inventory accumulation was cut back between the second and fourth quarters.

Two-quarter growth of domestic final demand peaked as long ago as the second quarter of 2016, with the moderation since then consistent with a decline in six-month real narrow money growth from a peak in January 2015 – see chart. Monetary trends recovered modestly in the first half of 2017 before turning down again late in the year. Domestic final demand growth may stabilise or rebound in early 2018 but prospects for the second half appear lacklustre.

GDP growth has probably remained solid in early 2018, partly reflecting a rebound in inventory accumulation, but global cooling, the stronger euro, softer domestic final demand and a fading of the inventories boost may combine to produce a significant slowdown during the second half of the year.

The recent dependence of GDP growth on net exports may heighten ECB concerns about euro appreciation but any attempt by President Draghi to “talk down” the currency at this week’s press conference would risk enflaming US protectionist sentiment.

Incoming monetary news continues to suggest that the global economy will lose momentum over the remainder of 2018. This slowdown will probably be driven partly by a rolling over of the US / global stockbuilding or inventory cycle.

With near-complete January monetary data now available, six-month growth of real narrow money in the G7 plus emerging E7 economies is confirmed to have fallen to its lowest level since 2008. Real broad money growth also weakened further – see first chart.

Real narrow money growth has fallen similarly in the G7 and E7 groupings, suggesting a synchronised economic slowdown across developed and emerging economies – second chart.

Euroland, the UK, Canada and Australia, among others, have released January monetary data over the past week. Real narrow money growth recovered slightly in Euroland – see previous post – but there were further falls in the UK and Canada; Australia, meanwhile, moved into contraction – see third chart.

The US may have joined Australia in negative territory in February, judging from weekly data – see fourth chart*. As previously discussed, US narrow money trends rebounded strongly 3-5 months after previous large tax cuts were legislated, so we are on the alert for a recovery in the data starting over March-May. 

The primary indicator used here to assess the status of the global inventory cycle is the annual change in G7 stockbuilding expressed as a percentage of GDP – equivalent, to a very close approximation, to the contribution of stockbuilding to annual G7 GDP growth. This series has reached troughs every 14 quarters on average since the 1960s, consistent with economists’ assessment based on earlier historical data of a cycle length of between three and five years – fifth chart.

The negative impact of stockbuilding on annual G7 GDP growth reached a maximum in early 2016 – a fading of this drag was an important driver of accelerating global activity in late 2016 / 2017. The contribution turned slightly positive in the third quarter of 2017 but fell back in the fourth quarter. A reasonable hypothesis is that companies were surprised by the strength of final demand in late 2017, so were unable to increase inventories to the extent desired.

If this hypothesis is correct, firms would be expected to boost production and stockbuilding strongly in early 2018 in an effort to restore the desired ratio of inventories to sales. This appears to be happening: the US ISM manufacturing inventories index, which is based on the net percentage of firms reporting a rise in stock levels, correlates with the G7 stockbuilding growth contribution and surged in February, reaching a high level by historical standards – fifth chart.

The finished inventories index of the Markit global manufacturing purchasing managers' survey also rose sharply last month.

The expectation here is that the growth impact of G7 stockbuilding will peak in the first or second quarter of 2018, fading during the second half and turning negative ahead of the next cycle trough, which – based on the historical average cycle length – could occur in mid-2019.

*The final data point in the chart is an estimate based on the average level of the nominal money stock in the three weeks to 19 February and an assumed 0.2% rise in consumer prices  (seasonally adjusted).