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Europe and emerging countries lift global growth

Global Overview

June 2017

Europe and emerging countries lift global growth

Even as U.S. economic growth trends so far this year have fallen short of the optimistic forecasts made after last November’s presidential election, the Eurozone and select emerging countries appear to be gathering speed. The Eurozone economy has outpaced the U.S. in aggregate growth for the last several quarters, and is expected to expand even faster during the second half of this year. Consumer demand in the Eurozone remains healthy while the rebound in global trade and the relatively weaker currency are helping exports.  However, growth in the U.K. economy is likely to be lackluster as business and consumer sentiment has hobbled on Brexit-related uncertainties. Growth trends in Japan are also above forecasts, despite the soft labor market conditions that have restricted consumer demand. Large resource exporters such as Canada and Brazil are yet to see any moderation in growth, though commodity prices have come off from levels seen at the beginning of this year.

Emerging economies, led by China, are expected to see faster growth this year. Consumer demand remains healthy across the emerging world, and supports aggregate growth. Even in countries such as Brazil and Russia that are emerging out of deep recessions, consumer spending appears to be improving. Interest rates remain relatively low in emerging countries, while stable currencies and inexpensive valuations continue to attract capital inflows. Political risks have also eased when compared to last year, except in Brazil where new allegations against the president could hamper the reform agenda.

The global manufacturing sector expanded at a robust pace in June, capping one of the strongest quarters in nearly two years. The Eurozone saw the most gains even as the pace of expansion slowed in the U.S. and China. New order flows have been notably stronger during the first half of this year, suggesting further output gains in the near term. Output growth in the global services sector accelerated in June, helped by stronger expansion in China and the U.S.


Global industry spotlight for the month: Banking

The global banking industry continues to see earnings expansion as credit demand remains healthy in the developed world while funding costs are stable. The risk of negative returns on balances maintained with central banks has disappeared as quantitative easing programs in Europe and Japan are likely to be unwound over the next few years. In the U.S., delays in the expected easing of regulatory controls have not yet disappointed investors as bank margins in conventional lending have expanded. In emerging countries, provisions for loan losses have come down steadily over the last year as improved economic conditions and higher commodity prices have helped revive cash flows in most sectors.

Healthy credit demand, growing fee income, and tight control over costs have supported earnings growth at the large U.S. banks in recent quarters. This trend is likely to continue as the interest rate hikes by the Federal Reserve should help protect net interest margins, and allow further expansions if demand for loans remains strong. Income from advisory and intermediation continues to grow, from both business and retail customers. These gains have more than offset the persistent weakness in areas like fixed income trading that were prominent profit centers in earlier years. The steady expansion in revenue and earnings has also held back investor disappointment over the delayed regulatory overhaul. The much anticipated easing of regulatory restrictions in the banking industry is considered unlikely before the end of this year. The most recent review by the Federal Reserve showed that almost all of the largest U.S. lenders have sufficient capital buffers to survive a crisis. Accordingly, the large banks have been allowed to step up buy backs and increase dividend payouts.

The better than expected economic trends in Europe and Japan should help the banking industry in those regions as well. Compared to their American peers, the European banks were slow in rebuilding their balance sheets after the crisis. The banking industry in select European countries, such as Italy, still suffers from low capital buffers and weak asset quality. Nevertheless, the overall health of the banking industry in Europe has improved over the last year. Even some of the British and German banks that have struggled to improve earnings for several years now appear to be recovering. Despite the challenges in Italy, the European banking union also appears to be gaining strength. The union should get a further lift if Sweden and Denmark join as expected.

More banks are likely to scale down their London operations over the next two years as the U.K. exits the European Union. Parts of the operations that involve EU regulations are expected to be relocated to other European cities such as Frankfurt and Paris. This process is likely to bring down income levels in London and the Bank of England is expected to hold its benchmark rates unchanged during the transition period.

Banks in large emerging countries are likely to gain from the sustained expansion in consumer credit demand, as well as a recovery in business loans. As these economies are now in better shape, compared to recent years, growth in loan losses have come down. In select countries in South East Asia, credit costs have declined from last year. Inflation risks are well contained, and should allow central banks to maintain current benchmark interest rates in most countries. If the economic recovery is sustained, funding demand for longer-term projects could increase as businesses step up capital spending. In Latin America, Brazilian banks should benefit from further rate cuts by the central bank. Banks in emerging countries are also better capitalized when compared to previous downturns, with better credit risk monitoring systems in place.







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© Thomas White International, Ltd. 2017