Thursday, September 27, 2012

EIU forecast—Central banks step in, but weaknesses remain
The outlook for the global economy is mixed: growth is slowing, but the announcement of significant new measures by the world's two largest central banks has encouraged investors. Financial pressures in the euro zone, in particular, have receded. However, trading conditions remain difficult, and our latest monthly forecast downgrades 2012 growth prospects for a number of countries—most notably China. In addition, we have lowered fractionally our global growth forecast for 2013.
We still expect global GDP at purchasing power parity (PPP) to grow by 3.1% this year, but we now believe that the recovery in 2013 will be slightly weaker than previously forecast. Global growth next year will be 3.5% at PPP exchange rates. This marks a downgrade from 3.6% last month and reflects the continuing slowdown in major economies. US growth decelerated for a second straight quarter in April-June and is now growing at less than half the pace it was at the end of last year. The euro zone remains mired in recession, and would be doing even worse were it not for mild German growth. China, increasingly an engine of global as well as Asian growth, is taking longer than expected to feel the benefits of policy stimulus. We now expect Chinese GDP growth in 2012 to fall below 8% for the first time since 1999.
That said, the last month has been notable for a series of positive developments for the global economy, which have been welcomed by investors. In Europe, the European Central Bank (ECB) has announced a programme to buy government bonds from countries such as Spain and Italy in potentially unlimited quantities. By far the ECB's boldest move to date, the programme reduces the likelihood of market panic and limits the risk of contagion. The German constitutional court's recent favourable ruling on the euro zone's permanent bail-out fund has also been crucial in calming nerves. Spanish and Italian government bond yields have fallen sharply, indicating improved investor confidence.
Spanish government bond yields
The other key development has come in America, where the US Federal Reserve has announced a third programme of quantitative easing (QE). Like the ECB's move, QE3 is significant in providing open-ended support for the US economy: the Fed says it will buy some US$40bn of mortgage-backed securities every month until the jobs outlook recovers, and has also indicated that it will not immediately turn off the monetary taps when conditions improve. Whether or not QE3 will invigorate the US economy is hotly debated, however. It should boost asset prices and could thus trigger a wealth effect that raises consumer spending. But its side-effects could include higher oil and commodity prices.
The risks to the global economy remain on the downside. A solution to the euro zone's debt crisis, even if achievable, will at best take shape slowly. In the meantime, any number of triggers—from anti-austerity politics in various countries to renewed disagreements between Greece and its creditors—could cause markets to take fright. In the US, the electoral cycle means that Congress has only a narrow window in which to steer the economy away from the "fiscal cliff" at end-2012. China is entering a tricky political transition that, if mishandled, could have implications for the economy.
Developed world
US economic growth was a subdued 1.7% (at an annualised rate) in the second quarter, and soft jobs data in July and August suggest that prospects for the second half of the year are not particularly bright. QE3 is unlikely to have a visible impact until almost the end of the year. We forecast average GDP growth of 2.1% in 2012 and 1.9% in 2013. We have not yet raised next year's forecast because of the new QE programme, but will soon be doing so. Nonetheless, any boost to GDP will be modest.
The euro zone's debt crisis is unresolved, but we believe that the framework for an eventual solution is falling into place. The ECB's new bond-buying programme and its pledge to do "whatever it takes" to save the euro have bought policymakers time, and progress is being made on fiscal and regulatory integration. This is not to downplay the severe economic difficulties still facing most countries in the currency zone, especially those in the so-called "periphery". Greece's long-term future as a euro member looks difficult. We expect the economic downturn in the euro zone to continue into the second half of the year, driven by fiscal austerity. In so far as there is a recovery in 2013, we expect it to be weak, with growth of 0.4%, as fiscal cuts will still be necessary in most countries.
The outlook is rather brighter in Japan. We have raised our 2012 forecast for economic growth to 2%, from 1.7%. Reconstruction spending after last year's tsunami and earthquake is having a more pronounced effect than we expected. However, growth will slow to 1.2% next year as the post-disaster boost comes to an end. Longer-term growth prospects remain weak.
Emerging markets
A combination of recession in Europe, sluggish demand in the US and general risk aversion has hit the developing world. In Asia, there are signs that the Chinese economic juggernaut is losing momentum, and we have cut our 2012 growth forecast from 8.1% to 7.8%. Although the delay in the effects of stimulus means lower growth this year, it should result in stronger data in 2013. We have, accordingly, slightly raised our China growth forecast for next year to 8.6%. Elsewhere in emerging Asia, India has slowed sharply and will grow by barely 6% in the current fiscal year. South-east Asia's trade-oriented economies are exposed to weak demand in the West and in China, but their fundamentals are generally positive.
Notwithstanding recent upbeat developments, the euro crisis has dented immediate growth prospects for the transition economies of eastern Europe. Many of these countries rely heavily on the euro zone for trade, investment and financing—although oil-rich countries such as Russia have been more insulated from the crisis. Eastern Europe remains vulnerable to further problems in the euro zone, but the ECB's latest actions have made the risks to our forecast—which previously were skewed to the downside—more balanced. Regional growth will slow to 2.5% this year but should pick up to about 3% in 2013.
Growth in Latin America is set to slow for a second consecutive year in 2012, reflecting a range of factors from outright contraction in the euro zone to below-par growth in the US. It also reflects a further downward revision to our forecast for Brazil, Latin America's largest economy. Brazilian GDP will grow by just 1.5% this year. However, the economy may have turned the corner, and we expect stimulus to carry over into 2013, when growth will pick up to over 4%. Latin America as a whole will also see stronger growth in 2013, thanks to resilient domestic demand and a recovery in the OECD.
Economic contractions in Iran and Syria, as well as weak growth in Egypt, will affect prospects for the Middle East and North Africa this year. Sanctions and lower oil output will hit Iran, although other oil-producing countries in the region will generally perform very well. Regional growth will pick up slightly in 2013, thanks to massive infrastructure programmes in Saudi Arabia and other Gulf states. In Sub-Saharan Africa, the outlook has weakened noticeably since our last forecast. We now expect growth of 4.1% this year and 4.4% in 2013. Any significant slowdown beyond what we already predict for China—a crucial economic partner for Sub-Saharan Africa—would be of particular concern.
Emerging-market growth
Exchange rates
The US dollar has given back most of the gains it had recorded since April, with much of the decline coming in the past six weeks. Deciphering movements in currency markets has been particularly challenging in recent years, but this latest shift is easier to explain. The dollar has declined as sentiment in the euro zone has improved, and as investors have priced in a third round of QE in the US (duly announced by the Fed in mid-September).
Looking ahead, we see two possible paths for the euro:dollar exchange rate. If conditions in the euro zone continue to improve, the dollar could weaken further and breach US$1.40:€1. Alternatively, renewed market concern over the euro zone could again erode confidence in the euro, boosting the dollar. Given the propensity of market fears to overwhelm all else, and with euro sentiment certain to face more setbacks, we see a limited upside to the euro's recent rise. We therefore retain our 2012 forecast for an average exchange rate of around US$1.28:€1, with the dollar strengthening slightly to US$1.26:€1 in 2013.
The Fed's announcement of QE3 is undeniably positive for commodity prices, especially when combined with further Chinese stimulus and the ECB's latest moves to stabilise the crisis in the euro zone. However, investors may already have priced in much of the good news. Markets might pause now before potentially strengthening again if and when the physical impact of QE—in terms of stronger commodity demand—materialises. Of all the commodities, gold is perhaps the most obvious beneficiary of the Fed's move. Gold's properties as a store of value and as a hedge against inflation will be attractive to investors given expectations of a long period of low interest rates and unorthodox monetary relaxation.
Oil prices have rebounded strongly from a low of US$88/barrel (dated Brent Blend) in mid-June to US$117/b in mid-September. We forecast an average oil price of US$109.5/b this year. Based on our estimates of market fundamentals and our subdued outlook for global growth, we expect prices to fall back again moving into 2013.
World economy: Forecast summary
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Real GDP growth (%)
World (PPP exchange rates) a 2.4 -0.8 5.0 3.7 3.1 3.5 4.0 4.1 4.2 4.1
World (market exchange rates) 1.3 -2.3 3.9 2.6 2.2 2.4 2.9 2.9 3.0 2.9
US -0.3 -3.1 2.4 1.8 2.1 1.9 2.1 2.2 2.3 2.3
Japan -1.1 -5.5 4.6 -0.7 2.0 1.2 1.6 1.2 0.9 0.8
Euro area 0.2 -4.3 2.0 1.5 -0.4 0.4 1.2 1.4 1.4 1.2
China 9.6 9.2 10.4 9.2 7.8 8.6 8.0 8.0 7.8 7.8
Eastern Europe 4.6 -5.6 3.4 3.8 2.5 3.0 3.7 3.7 3.9 4.0
Asia & Australasia (excl Japan) 5.5 5.0 8.4 6.5 5.7 6.4 6.5 6.5 6.5 6.4
Latin America 3.9 -1.9 6.0 4.3 3.1 3.9 4.2 4.0 4.1 4.1
Middle East & North Africa 4.4 1.7 5.2 3.4 3.4 3.9 4.7 4.9 5.3 5.0
Sub-Saharan Africa 4.8 1.2 4.4 4.4 4.1 4.4 5.0 5.0 5.2 5.0
World inflation (%; av) 4.9 1.5 3.0 4.1 3.4 3.3 3.4 3.4 3.3 3.2
World trade growth (%) 2.4 -11.7 14.3 6.3 3.5 4.6 5.3 5.7 5.7 5.4
Commodity prices
Oil (US$/barrel; Brent) 97.7 61.9 79.6 110.9 109.5 103.4 104.5 107.3 110.0 115.0
Industrial raw materials (US$; % change) -5.3 -25.7 45.4 21.1 -18.6 7.4 4.2 2.7 1.1 1.3
Food, feedstuffs & beverages (US$; % change) 28.1 -20.3 10.7 30.1 -2.8 -0.9 -5.6 -2.8 1.1 1.9
Exchange rates (annual av)

¥:US$ 103.4 93.6 87.8 79.8 79.4 82.6 86.7 89.0 92.2 91.4
US$:€ 1.47 1.39 1.33 1.39 1.28 1.26 1.25 1.24 1.26 1.26
a PPP = purchasing power parity
Source: Economist Intelligence Unit.

- Umesh Shanmugam

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