Fasten your seatbelts

If you have been hibernating lately, there won't be all that much in our latest macroeconomic forecasts to catch you by surprise. All the adjustments to our inflation, current-account and economic-growth forecasts are quite minor. For the United States, we have increased our growth expectations slightly, and are now penciling in an increase of 2.7% in gross domestic product (GDP) in 2018. This largely reflects strong incoming data so far this year. Conversely, we have taken down our 2018 GDP-growth forecasts a shade for both the Eurozone and the United Kingdom, to 2.2% and 1.4%, respectively. Our 2019 forecasts remain unchanged, at 2.4% for the U.S., 1.9% for the Eurozone and 1.6% for the UK.

Such modest changes might seem odd. Rising trade tensions, not to mention an internationally increasingly isolated U.S. administration, continue to generate unnerving headlines. Meanwhile, at the beginning of June, it briefly looked as if we might be seeing a return of the Eurozone debt crisis, during the haphazard formation of the new Italian government. German and British domestic politics has also seen some turmoil – making progress towards a common European migration policy, a banking union or a smooth Brexit no easier.

So, are we complacent not to implement bigger changes to our forecasts? On balance, we do not think so. To start with Italy, events in the past few months have been quite instructive. The political situation in Rome has been unstable and bewildering for a while. Even before the March election, it was pretty clear that there was a non-negligible chance of populist forces gaining majorities in both houses of parliament and forming a government together. Similarly, it has long been clear that to function in the longer term, the Eurozone needs additional institutional support. These where some of the reasons why we did not increase our Eurozone growth forecast more aggressively in the last quarter. We think that it is still reasonably conservative, reflecting both upside and downside risks to our base case. The initial statements of the new Italian government are fairly encouraging. Italy's new finance minister Giovanni Tria has ruled out abandoning the euro. Given the still solid underlying economic momentum, it appears more reasonable to wait for what the government does, rather than making knee-jerk adjustments to our forecasts. As for Germany and France, we have also incorporated some fall-out from recent trade tensions.

Make no mistake, in our opinion the impromptu attacks by the Trump administration on free trade are, to put it mildly, fundamentally misguided and frighteningly uninformed. They also risk reducing the growth prospects of the U.S. and the world economy as a whole. To us, it seems obvious that eroding the rules-based international order underpinning global trade and undermining international supply chains will hurt everyone involved, including emerging markets. However, it is also unlikely to cause a global recession anytime soon. As for Brexit and monetary policies, these are clearly issues we continue to watch. In UK politics, we see some encouraging signs that a hard Brexit will be avoided, but it is too early to bank on it. Against the uncertain political backdrop, the European Central Bank (ECB) has just outlined its path for the quarters to come, with no rate rise expected until the second half of 2019. The U.S. Federal Reserve (the Fed) looks similarly keen to avoid policy errors. So far, the signs of the U.S. economy overheating are few and far between. Fed policy will continue to depend on incoming data. We currently expect a total of three to four rate hikes between now and the end of 2019, taking the federal funds rate to three to four 3.25%.

Given all that, what are the risks to our forecast? Probably the biggest – and a growing one – might be turbulence in financial markets, leading to a significant tightening in global financial conditions. In addition to the potential triggers already mentioned, there are plenty of other risks, such as a sudden spike in oil prices, caused, for example, by renewed tensions in the Middle East or Venezuela's default. That should be the real lesson from recent events in Italy: the world is uncertain and monetary support is waning. With markets already nervous, the risks of a downward spiral are larger than they were six months ago.

Politics aside, Italy has actually gotten better

In recent years, Italy has seen a steadily growing current-account surplus. Compared to economic output, government debt has stabilized.

Europe is not all that dependent on U.S. trade

As a percentage of GDP, the direct exposure of Eurozone countries to U.S. trade sanctions on their exports is fairly small.