The Fed and the European Central Bank

About the author:

Michael Knox
Author name:
By Michael Knox
Job title:
Chief Economist and Director of Strategy
Date posted:
30 June 2017, 10:30 AM

The US Economy

The US Bureau of Economic Analysis has revised up the first quarter of GDP from 0.7% to 1.2%. We think the US economy will grow by 3% in the second quarter of 2017. This should slow in the third quarter to 2.9%. By the time the fourth quarter arises, growth in GDP should ease further to 2.5%.

Because of the weak first quarter, we think that growth for the full year will be 2.3%. This is stronger than the Federal Reserve estimate for 2017 of 2.2%. This relatively low GDP growth hides the emerging strength of the US economy. This emerging strength happens because of a surge in investment. There are two main areas where this surge in investment is occurring.

The first of these two areas is mining and petroleum. Weak oil prices in 2015 and early 2016 saw a slump in investment in this sector. Investment in non-residential construction in the mining and petroleum area slumped by 30% in 2015. It slumped again by more than 40% in 2016. This slump in investment generated the weakness in the US economy in 2016 where we saw growth for the year decline to only 1.6%.

The recovery in US oil prices in the second half of 2016 and the relative stability of those prices in the first half of 2017 has seen a dramatic acceleration of non-residential construction in the oil and gas sector. After a decline in investment of around 70% in 2015 and 2016, the mining and petroleum sector is adding back all of that investment in calendar 2017. This means that growth in non-residential construction in the mining and petroleum sector is up by some 70% in 2017. This acceleration of non-residential construction will continue through to the third quarter of 2017.

The second area of strong investment growth is in transport equipment. A stronger level of activity in the US economy is generating a stronger demand for travel. This is particularly true of air travel. This increase in demand for air travel has generated an increasing demand for US airlines. Investment in the aircraft sector should rise around 20% in 2017 and adds a further 15% in 2018.

This increase in domestic activity generates an increase in demand in the US economy. After rising by only 2% in 2016, gross national expenditure should rise by 2.3% in 2017 and 2.5% in 2018. All of this adds up to GDP growth rising from 2.3% in 2017 to 2.7% in 2018. Our estimate for growth for the US economy of 2.7% in 2018 is way higher than the Federal Reserve's estimate of 2.1% in 2018. We think this means that as we move into 2018, the Federal Reserve will have to move more aggressively than it currently believes.

The Euro Area

In his speech on 8 June 2017, the President of the European Central Bank Mario Draghi confirmed that quantitative easing would continue. Regarding non-standard monetary policy measures, he confirmed that net asset purchases would continue at the current rate of 60 billion Euros per month. These purchases would continue until the end of 2017, or beyond if necessary. They would continue until the governing council sees a sustained rise in inflation to a target of below but close to 2%, over the medium term.

The Euro Area economy is looking better. It grew by 0.6% in the first quarter of 2017 after rising by 0.5% in the final quarter of 2016. He said that survey results continue to point to solid broad-based growth. In particular, recovery in investment continues to benefit from very favourable financing conditions and improvements in corporate profitability. He said that staff projections by the European Central Bank see GDP rising by 1.9% in 2017, by 1.8% in 2018 and by 1.7% in 2019.

Draghi has always argued for, what Australians call, micro economic reform. He stated that economic growth prospects continue to be dampened by the slow implementation of structural reforms, in particular in product markets. This means he wants trade barriers within the Euro Area, caused by individual country regulation, to be reduced much more aggressively.

He said that the ECB staff see the Euro Area inflation rising by 1.5% in 2017. This eases to 1.3% in 2018. It then recovers to 1.6% in 2019. This weakness in inflation is caused by a stable outlook for oil prices.

The big problem that the Euro Area had in 2012 and 2013 was a slump in business lending. This is measured at the annual growth rate of loans to non-financial corporations. Draghi noted that this has been improving since 2014. He said that growth in loans to non-financial corporations increased by 2.4% in the year to April 2017. The annual growth rate of loans to households was also 2.4%.

He said "the pass-through of monetary policy measures, put in place since June 2014, continues to significantly support borrowing conditions for firms and households, access to financing, notably for small and medium sized enterprises and hence credit flows across the Euro Area."

He finished by repeating his call for structural reforms. He said the implementation of structural reforms needs to be substantially stepped up to increase resilience, reduce structural unemployment and boost productivity and potential output growth.


Unlike 2007, the US and Europe are now at very different points of their own business cycle. The US is approaching the end of its business cycle. Strong growth and low unemployment mean the Fed must continue to tighten.

In Europe, growth is only now beginning to accelerate. There is still a very large pool of unemployed that needs to be absorbed. The need for more employment means that the European Central Bank must continue to provide stimulus for the Euro Area economy.

When the US economy finally does slow down, it will be in the context of a strongly growing European economy. World growth is no longer synchronized.

More information

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