At the time of writing, the number of new cases of Coronavirus are still increasing, although the pace is thankfully declining. This is widely thought to be as a result of the measures taken in China to prevent people mixing with each other such as enforced and often unpaid holidays, travel bans, conference bans, and even in Beijing – a crackdown on family parties. Several countries have introduced travel bans and many companies around the world have banned travel to China and Hong Kong. 

Whilst the health benefits of such measures appear to be paying off, there will be a less beneficial effect on the Chinese and global economies. Economists are finding it hard at present to estimate the effects, but what they can all probably agree on is that GDP growth in Q1 for China will be substantially lower. Given China plays such a large part in the global supply chain it then follows that we can also expect a substantial ripple effect around the globe. One US Federal Reserve Open Market Committee (FOMC) member, Robert Kaplan, yesterday suggested that it could reduce US GDP growth by as much 0.4 %.

There will also be an effect on inflation via two channels. Firstly via the oil price. Inflation around the world is very low and movements in the oil price have a much larger effect on inflation rates than in previous eras (when there was more inflation in other parts of the economy). Spot oil prices have fallen nearly 20% this year in reaction to the weaker global economic outlook and some of this will quickly pass through into lower fuel costs and lower inflation rates. Some economists are beginning to factor this into forecasts and US CPI is now expected to fall to below 1.5% year-on-year by mid-2020. The second effect is via a weaker Chinese currency and will take longer to impact inflation trends. Quite sensibly, some easing measures have been announced in China and it is possible that there will be more to come. This should stop any currency appreciation – thus making Chinese exports cheaper to the rest of the world. This reduces input costs into many supply chains, making it easier for producers outside China to keep prices low.

Central Banks should be concerned at this development, especially the ones that have an inflation target as their objective. In Europe and the UK the outlook for inflation was already subdued, but both the Bank of England and the ECB are very reluctant to cut rates any further. The Bank of England failed to cut rates in January despite some dire economic forecasts (see piece written by James Lynch – Will the new boyfriend be any more reliable?). The ECB is also cautious because they have a new president and are conducting a policy review. There is a suspicion creeping into central bank circles that the long term effects of negative interest rates are also turning out to be harmful thus tying the ECB hands from any further easing. Already the Swedish Central bank has exited its negative interest rate policy whilst also downgrading economic forecasts. Similarly, the Bank of Japan remains stuck when it comes to monetary policy.

That just leaves the US Federal Reserve. Inflation in the US is likely to record around 2.3% year-on-year in January, but this may be the only month in 2020 that inflation is above 2% as it declines into the summer months. Falling inflation with a weakening economy should lead the FOMC to continue cutting rates in 2020.

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