Brewed for decades: Cyprus' perfect financial storm

• The Cypriot banking catastrophe was a momentous point in economic history at which a tiny island suffered such acute financial distress that it shook the entire Eurozone. Here we trace how Cyprus go to that point, via a series of mishaps and misjudgements, and missed escape routes going back over four decades.
• Cyprus will go down in history as one of the closest there has ever been to a perfect storm of financial instability, brewed from terrible decisions by its banks, supervisors and politicians; compounded by rotten luck and bad timing. Even Cyprus’ political and financial strengths made things worse by delaying firm action and allowing losses to build. Most imaginable horrors that could happen to a banking system did happen, and that was even before the controversial and partially botched international rescue operation.
• It was an international crisis in many senses of the word. The crisis was hosted in Cyprus, massively escalated by events in Greece, and paid for in large part by Russian depositors.
• There are lessons for Greece, but the experiences also have important differences. Crucially, there was a strong constituency in Cyprus to support painful austerity and structural reforms necessary to get rid of capital controls. That does not exist in Greece.
• The dramatic unfolding of events on the night of 15 March 2013 also provides a lesson that was not heeded in Greece. All‐night negotiating sessions against hard‐deadlines tend to lead to highly flawed agreements, though they are also a symptom of such commitment to the euro that things might work out in spite of the flaws.

     

World Economic Prospects

Overview: Markets rally but risks still to the downside

• Our growth forecast for 2016 is steady this month at 2.3% but the forecast for 2017 has been cut again, to 2.7% from 2.9%.
• The near‐term growth outlook has been supported by a decent rally in financial markets. Since mid‐February, world stocks have gained around 8%, US high yield spreads have narrowed around 140 basis points and a number of key commodity prices – including oil – have also risen.
• Another supportive trend is still‐healthy consumer demand in advanced economies including the US and Eurozone. Although there has been some slippage in consumer confidence, it has been modest compared to either 2012–13 or 2008–09.
• So overall, the global economy still looks likely to avoid recession and strengthen a touch next year. But risks to the outlook remain skewed to the downside.
• Despite the recent market rally, world stocks still remain below their levels at end‐2015 and well below last May's peak. Financial conditions more broadly also remain significantly tighter than in mid‐2015, and inflation expectations somewhat lower.
• And there are still negative signals from incoming data. The global manufacturing PMI for February showed output flat while the services PMI showed only very modest growth – both were at their lowest since late 2012.
• Economic surprise indices for both the G10 and emerging markets also remain in negative territory, and our world trade indicator suggests no improvement from the dismal recent trends.
• Notable growth downgrades this month include Germany, Japan, the UK, Canada and Brazil.
• In our view, policymakers still have scope to improve the outlook. The latest ECB moves – more negative rates and more QE – will help a little. Widening of QE to corporate bonds also hints that more radical policy options are coming into view. But policies such as central bank equity purchases or money‐financed fiscal expansions will probably require global growth to weaken further before they become likely.

     

Brexit adds to gloom over long‐term growth prospects

• The prospect of continued weak productivity growth and less support from rising labour supply means we are relatively gloomy about medium‐term growth prospects. Our forecasts show potential output growth of just 1.6% a year from 2017–2030. This would be well below the average of the decade prior to the financial crisis (2.7%) and in line with our estimate for the 2007 and 2016 period which included the global financial crisis.
• We have become more pessimistic about the extent to which growth in total factor productivity is likely to accelerate. This is partly due to a judgement call that more of the weakness since the financial crisis reflects structural factors. Brexit is also likely to weigh on long‐term prospects, resulting in a degree of trade destruction and lower FDI inflows than would be the case were the UK to remain in the EU. Brexit is also likely to result in less capital deepening.
• Demographic factors also point to weak potential output growth moving forwards. High levels of inward migration have mitigated the impact of an ageing population recently. However, immigration is likely to fall sharply over the next decade, as first an improving European labour market reduces incentives to migrate and then the UK Government adopts more restrictive immigration policy. We are also coming into a period where there will be fewer increases in state pension age than of late.
• Since the mid‐1990s there has been a surge in the number of people going to university, resulting in strong contributions from human capital. But this will be less important moving forwards as university admissions reach a ceiling.
• Stronger growth in potential output would be possible if Brexit results in trading arrangements which are closer to the status quo, or if policy is more ‘liberal’, than our baseline assumptions.

     

How would Eurozone equities respond to a bond sell‐off?

• We have developed a new model to measure the impact on Eurozone equities of a global bond sell‐off as the Fed starts to tighten its monetary stance later this year. We show that the most affected countries would be Greece, Finland and Portugal: the cumulated equity loss compared to the baseline ranges from between 35% to more than 50% in the case of Greece at the end of 2017. Under this scenario, Belgium, Ireland and Austria are less impacted by the global re‐pricing of risk.
• In light of global risk being skewed to the downside (China, Greece, risk‐off), it is essential to have a framework that is able to generate consistent responses of Eurozone stock indices to global macro shocks in stress test scenarios. The approach assesses first the co‐movements of Eurozone stock indices and aims to explain them with macro variables such as the US S&P index, the oil price, the euro/dollar exchange rate and short‐ and long‐term interest rate differentials between the Eurozone and the US.
• We find a high degree of co‐movement in Eurozone equity returns. This matters from an asset management perspective, as it reveals limited potential for diversification benefits of an equity portfolio invested across Eurozone countries.

     

Global economy robust to higher oil,but EM vulnerable

• ? We do not envisage major central banks being pricked into deflationary action by the oil spike as there are limited concerns over a wage‐price spiral. But further rises — say to $100pb — would sour the global economy's ‘Goldilocks’ period. Vulnerable EM are the biggest concern; for some the impact is relatively large and could pile pressure on already‐strained domestic policies .
• ? A comparison with historical precedents is generally consoling. First, the price rise of 60% in the last year — though big — is only the sixth largest since 1973. Second, oil‐related global slowdowns have usually been associated with central bank hikes, which are less likely now than in past periods when inflation was less well anchored.
• ? Global implications: our baseline forecast of $80bp in H2 2018 may prompt a modest rise in non‐energy inflation and wages, and slightly weaker GDP growth. But we anticipate limited monetary policy responses. Concerns about the negative impact on activity are likely to trump fears of second‐round inflation effects.
• ? Model simulations: souring Goldilocks' porridge. Our $100pb oil simulations reveal a peak impact in 2020, knocking 0.7% off the level of global GDP. Inflation rises 1.2pp above our baseline by 2019.
• ? The recent association between strong oil and a strong dollar is unusual, but is probably not reflective of a fundamental change in the usual historic relationship (strong oil‐weak dollar).
• ? Simulations suggest EM oil importers endure the biggest hits via a (i) sharp terms of trade reversal; (ii) dollar strength; (iii) capital flows reversals; and (iv) recent reductions of oil price subsidies leaving consumers vulnerable to price increases. The most affected include already‐vulnerable economies Greece, Argentina and Turkey, as well as EM heavyweights China and India.

     

The global bond sell‐off – why and where next?

• The rise in global bond yields since mid‐April has taken markets by surprise. Our analysis suggests that, on balance, some upward correction in yields was justified – especially in the Eurozone. For the US, the evidence is more mixed.
• A variety of explanations have been advanced to explain the bond sell‐off including Eurozone reflation/inflation, looming US rate hikes and associated uncertainty, liquidity and other technical factors, Chinese reflation and a simple reversal of yields overshooting to the downside.
• Some of these explanations are more convincing than others: in our view there is some modest evidence for increased uncertainty and liquidity effects but we also think bonds have corrected from overbought levels, especially in the Eurozone.
• Using some econometric models of bond yields suggests that the recent upward correction of German yields was probably justified; markets had pushed yields too low earlier in 2015. Indeed, the model implies a further ‘corrective’ rise in yields is possible.
• For the US, different models give slightly different results – a variant of the well‐known Shiller‐Modigliani model suggests yields should still be below 2%. However, a broader error‐correction model including factors such as fiscal variables and foreign flows into US bonds suggests the recent rise in yields was broadly justified.

     

Global growth to 2024: reversion to which mean?

• We expect global GDP growth to average 3.5% per year (at PPP exchange rates) over the next ten years. This is lower than the 3.8% recorded in 2000–14 though not dramatically so. There will be a modest recovery in advanced economy growth ‐ but not to pre‐crisis rates. Emerging market (EM) growth will slow but remain faster than growth in the advanced economies. And with EM's share in world GDP much increased from 10–15 years ago, EMs will continue to provide a large proportion of world growth.
• EM growth is expected to run at around 4.5% per year in 2015–24, well down on the 6% seen in 2000–14. This includes a slowdown from around 10% to 5–6% in China ‐ but China's share in world GDP has risen so much that China's contribution to world growth will remain very substantial.
• Advanced economies are forecast to grow by 1.9% per year in 2015–24, a big improvement from the 1% pace of 2007–14 (which was affected by the global financial crisis) but below the 1990–2014 average. Indeed, the gap between forecast G7 GDP and GDP extrapolated using pre‐crisis trends in potential output will remain large at 10–15% in 2015–24.
• Global growth will remain relatively strong compared to much longer‐term averages: growth from 1870–1950 was only around 2% per year. But a return to such low growth rates looks unlikely; China and India were a major drag on world growth until the 1980s but are now fast growing regions.
• Our forecast is relatively cautious about key growth factors; the contribution of productivity growth is expected to improve slightly, while those from capital accumulation and labour supply fall back. Demographics will be a more severe drag on growth from 2025–40. Overall, risks to our long‐term forecasts look to be skewed to the downside.

     

Eurozone equities expected to outperform in 2015

• We expect Eurozone equities to somewhat outperform US equities in 2015, so long as downside risks (such as a Greek exit from the Eurozone) do not materialise.
• Absolute valuation measures suggest that Eurozone stocks are fair‐to‐slightly cheap, limiting their upward potential. But relative to US stocks, they appear more attractive. This suggests potential for favourable portfolio reallocations and a possible lift to equity prices in the region.
• That said, earnings growth is likely to provide the main support to Eurozone equity performance in 2015, against a backdrop of converging earnings cycles between the US and the Eurozone.

     

UK inflation set to tumble below target by autumn

• ? We expect CPI inflation to slow markedly this year, dropping below the 2% target by the autumn. The inflationary impulse from the 2016 depreciation is fading and should partially reverse, while global food and energy prices are expected to stabilise. Base effects will become increasingly important.
• ? CPI inflation reached a five‐and‐a‐half‐year high of 3.1% in November, up from a little over 1% a year earlier. The 2017 pick‐up in inflation was the result of a perfect storm of a weaker pound, higher oil prices and sharp rises in domestic electricity bills. But inflation has subsequently slowed, reaching 2.5% in March. And, after a brief hiatus, we expect the downward trend to continue as we move through the year.
• ? The key driver of lower inflation will be weaker core pressures. In line with the literature, there is already evidence that the impact of sterling's depreciation is fading, and we think that the pressures could partially reverse if sterling continues to strengthen. We see little prospect of an offsetting escalation in domestic cost pressures. The recent pick‐up in wage growth has been muted and a further acceleration above 3% looks unlikely while there remains slack in the labour market.
• ? The food, petrol and energy categories contributed 0.8 ppt to CPI inflation last year, compared with a drag of 0.5 ppt in 2016, as stronger global pressures combined with the weaker pound. But as global prices have been more subdued of late, by the end of 2018, we expect these categories to be contributing 0.5 ppt to CPI inflation.
• ? The final element behind the expected slowdown in inflation is base effects. The comparison with last year's strong price pressures will depress the 2018 inflation rate, and we see the base effects being at their strongest mid‐year.
• ? We think it unlikely that such a slowdown in inflation would derail the MPC from hiking interest rates twice this year. But it could temper its hawkishness in 2019.

     

Slow but stable(ish) house price growth lies ahead

• ? UK house price growth is running out of steam. And with household incomes squeezed and the affordability of housing stretched, we think a prolonged period of very modest growth lies ahead. But the prospect of a crash is remote.
• ? At 2.6% in Q2 2017, annual house price growth is presently running at a four‐year low. This is a step change down from the recent peak of nearly 10% in mid‐2014 and average growth of 4% over the current economic expansion.
• ? Three developments are likely to lie behind this slowdown. The first is weak growth in households' real income, cutting the ability to save for a deposit or finance a move up the housing ladder. That said, past periods of sluggish income growth have not always been associated with low house price inflation.
• ? The second is the consequence of recent tax hikes imposed on buy‐to‐let investors and second‐home owners, which theory suggests should be capitalised in lower property prices.
• ? The third and perhaps most important reason is the increasing unaffordability of housing to an ever‐widening sub‐set of the population. The ratio of house prices to earnings is almost back at its pre‐crisis record. And the income of the average mortgage borrower is close to £60,000, more than double the average annual wage.
• ? This third factor has implications beyond price growth, suggesting both a permanently lower level of transactions and a further decline in the number of households with mortgages, continuing a trend which began at the beginning of the century.
• ? But set against these headwinds is the cushion provided by record lows for both mortgage rates and mortgage affordability. Overall, house prices are caught between a lack of traditional drivers of accelerating growth, but equally an absence of forces which have typically caused prices to fall. Hence, our expectation of a period of sluggish, but relatively stable, growth.

     

How low can U go?

• ? Although there is growing evidence that wage growth is building in response to low and falling unemployment in the advanced economies, there is scope for unemployment rates to fall further without triggering a pay surge.
• ? For a start, current unemployment rates in comparison to past cyclical troughs overstate the tightness of labour markets. Demographic trends associated with the ageing ‘baby boomer’ bulge have pushed down the headline unemployment rate – unemployment rates among older workers are lower than those of younger cohorts. And in a historical context, Europe still has a large pool of involuntary part‐timers.
• ? In addition, rising participation rates mean that demographics are less of a constraint on employment growth than widely assumed. In both 2017 and 2018, had it not been for increased activity rates (mainly for older cohorts), unemployment would have had to fall more sharply to accommodate the same employment increase. We expect rising participation rates to continue to act as a pressure valve for the labour market.
• ? Finally, unemployment rates were generally far lower during the 1950s and 1960s than now. If wages stay low relative to productivity, as was the case during that prior era, employment growth may remain strong, with unemployment falling further. In the post‐war era, low wages were partly a function of a grand bargain in which policy‐makers provided full employment in return for low wage growth.
• ? There is evidence to suggest that many post‐crisis workers have opted for the security of their existing full‐time job and its associated benefits despite lower wage growth, rather than change job and potentially earn more; the rise of the ‘gig economy’ has led some workers to value what they already have more. Put another way, the non‐accelerating inflation rate of unemployment (NAIRU) has fallen. So, the role of labour market tightness in pushing wage growth higher may continue to surprise to the downside.

     

Tighter labour markets to finally lift global wages

• Wage growth has been relatively slow since 2007 in advanced economies, but an upturn may be in sight. Slow productivity growth remains an issue but tighter labour markets make a positive response by wages to rising inflation more likely and there are signs that compositional and crisis‐related effects that dragged wage growth down are fading – though Japan may be an exception.
• Overall, our forecasts are for a moderate improvement in wage growth in the major economies in 2017–18, with the pace of growth rising by 0.5–1% per year relative to its 2016 level by 2018 – enough to keep consumer spending reasonably solid.
• Few countries have maintained their pre‐crisis pace of wage growth since 2007. In part this reflects a mixture of low inflation and weak productivity growth, but other factors have also been in play: in the US and Japan wage growth has run as much as 0.5–1% per year lower than conventional models would suggest.
• The link with productivity seems to have weakened since 2007 and Phillips curves – which relate wages to unemployment – have become flatter. A notable exception is Germany, where the labour market has behaved in a much more ‘normal’ fashion over recent years with wage growth responding to diminishing slack.
• ‘Compositional’ factors related to shifts in the structure of the workforce may have had an important influence in holding down wage growth, cutting it by as much as 2% per year in the US and 1% per year in the UK. There are some signs that the impact of these effects in the UK and US are fading, but not in Japan.
• The forecast rise in inflation over the next year as energy price base effects turn positive is a potential risk to real wages. But the decline in measures of labour market slack in the US, UK and Germany suggests wages are more likely to move up with inflation than was the case in 2010–11 when oil prices spiked and real wages fell.

     

World Economic Prospects

Overview: Forecasts steady but near‐term signals mixed

• Our world growth forecasts are steady this month, at 2.3% for 2016 and 2.7% for 2017.
• One factor behind the more stable outlook is the rally in financial markets since mid‐February. This rally appears to have been the result of a number of factors including a more dovish Fed and an improvement in some near‐term economic indicators.
• The implied 12‐month ahead Fed funds rate dropped around 0.5% from its January peak to mid-February and remains around 0.35% lower now. So the Fed still apparently has the capacity to boost markets with changes in communication policy.
• The Citigroup economic surprise indicators have also improved over recent weeks, especially for emerging markets where the indicator is back in positive territory. The G10 index nevertheless remains clearly negative.
• Other economic signals are mixed. The latest reading of OE's world trade indicator (based on survey evidence for March) suggests a modest improvement, although again the indicator continues to signal weak world trade growth.
• Meanwhile, there have been some warnings of potentially softer labour market conditions. Though payrolls gains have remained solid, a weighted sum of the employment subindices of the US ISM surveys has dropped sharply over recent months. A similar index for the Eurozone is more positive, although it has also softened from its late‐2015 peaks.
• These mixed signals suggest limited likelihood of near‐term upgrades to the world growth outlook and overall we maintain our view from last month that risks look skewed to the downside – so that further monetary policy stimulus remains a possibility.
• This assessment appears to be shared, to some extent at least, by global bond markets. US 10‐year yields have dropped back to only 1.7% since mid‐March (only 0.1% above their February lows), with German yields at just 0.1% and Japanese yields at ‐ 0.1%. So the ‘great squeeze’ on G7 bond yields is still continuing.

     

Wealth spurt unlikely to offer much aid to the consumer

• ? UK households are wealthier than ever, thanks to continued growth in house prices and a buoyant stock market. However, the nature and distribution of that wealth means that support for consumer spending from a ‘wealth effect’ is likely to be both small and less than in the past.
• ? In Q4 2016, households' holdings of owner‐occupied property and net holdings of financial assets amounted to £9.2tr, almost 8% up on the level a year earlier. This was equivalent to 719% of annual household gross disposable income, a near‐record high.
• ? A long‐established feature of economics is the concept of a ‘wealth effect’ – the premise that faced with rising wealth levels, households feel more comfortable and economically secure and hence spend more. But the economic literature differs on how large this effect is.
• ? Our own Global Model suggests that the wealth effect is modest, with a 10% rise in wealth boosting consumer spending by only around 0.2%. One reason is that about half of financial wealth consists of highly illiquid assets in pension funds. But this component has recently been the biggest source of growth in wealth.
• ? Given differences in the propensity to consume out of income and wealth, the concentration of financial and housing assets among better‐off households will also act to neuter the size of any wealth effect. The wealthiest one percent of households hold around 20% of household wealth. But the bottom quartile owns only 1.5%.
• ? Meanwhile, the housing market has created an ever‐greater concentration of wealth. The share of households owning their own property fell from 71% to 63% in the decade to 2015. But the share of private renters more than doubled in the same period, from 9% to just over 19%. And the pre‐crisis appetite to finance consumption by borrowing against the value of property shows no sign of returning.

     

The global impact of a sharper US‐China slowdown

• ? We forecast a moderate global slowdown through 2020, but risks are looming of a sharper downturn in China and the US. If these were to materialise, our simulations suggest global GDP growth would hit a post‐crisis low, with the level of GDP dropping by 0.6% and growth slowing by 0.4 ppt in 2019/20.
• ? Economies with strong trade linkages to China and the US – Korea, Taiwan and Mexico – would suffer most. Conversely, a weaker dollar, lower oil prices and relatively smaller trade flows with the US and China would offset the blow in Europe and for some EMs, including Turkey, Argentina and India.
• ? Since 2010, Chinese activity has been a powerful leading indicator of every major economy's exports, proving stronger than similar indicators for US or eurozone activity. This is even the case for non‐Asian economies such as Canada, Mexico, Italy, Germany, France and the UK. This may reflect deepening trading relationships and the relatively high volatility of Chinese cyclical indicators over the period.
• ? Over the past decade, global macro stability has been supported by the US and Chinese cycles moving counter to each other. But this could reverse if the ongoing Chinese policy stimulus fails to gain traction and the weakness gains momentum.

     

Venture capitalists and entrepreneurs become venture philanthropists

• Non‐traditional charitable sources of revenue may be categorised as follows:
  • Venture philanthropy: Human resources and funding invested as donation in the charity by entrepreneurs, venture capitalists, trusts and corporations in search of a social return on their investment. It involves high engagement over many years with fixed milestones and tangible returns and exit achieved by developing alternative, sustainable income.
  • Commercial ventures: They seek a financial return on investment by creating a social enterprise operated by charities and their trading/holding companies alone or in partnership with the corporate sector, venture capitalists or investors to provide funding. Venture philanthropists may also ‘invest’ without establishing an equity position in the commercial enterprise. Any profits are re‐directed to mission‐related activity, although the business activity may or may not be mission related.
  • Social venture capital: It funds commercial ventures (as above) but may not seek a complete return on investment; instead the investor may off set some or all of the investment against social outcomes.
• Within the context of venture philanthropy, this paper demonstrates how charities, venture capitalists and entrepreneurs may work together in strategic alliances. It explores venture philanthropy from the perspective of venture capitalists and entrepreneurs, giving examples. Charities are shown how to prepare themselves to take advantage of these entrepreneurial opportunities.
• Although the emphasis in this paper is on venture philanthropy, the processes outlined may be used to help a charity take advantage of opportunities within the broader social entrepreneurial context. Successful venture capitalists and entrepreneurs have demonstrated the ability to turn outline business ideas into big results, frequently in highly competitive business environments.
• A common characteristic that appears to unite these individuals when they divert their interest toward social ventures is a desire to apply their business‐like approach, which includes planning processes, milestones and outcome measurement to their social venture activity.

Copyright © 2005 John Wiley & Sons, Ltd.     

Trump versus Reagan – the global dimension

• ? Could the Trump era resemble the 1980s? ‘Reaganomics’ boosted world growth – but not necessarily in the ways people think – and not for emerging markets (EMs), a larger part of today's world economy. Growth then was also aided by factors such as declining interest rates, which are missing today, and we doubt that deregulation will lead to a productivity surge. US asset prices, meanwhile, were depressed in 1981, unlike now, so the big gains of the 1980s are unlikely to be repeated. EM assets should do better than back then, though.
• ? Optimistic observers – and to some extent, markets – have been drawing parallels between the policy mixes of the Trump and Reagan administrations, and talking up the prospects of stronger global growth. But while the US did support world growth in the 1980s, this was arguably more due to Keynesian' demand‐side policies than supply‐side ones: Reagan's record on supply‐side policies was mixed.
• ? The US is still an important driver of global activity, but markets may be too optimistic about the effect of Trump's policies on world growth. Any Trump fiscal stimulus will occur against a much less favourable background than that of the 1980s, when US growth also benefitted from a variety of factors missing now.
• ? It is also unclear whether Trump's administration will tolerate large expansions of the current account and fiscal deficits as the ‘price’ for more growth. And we are sceptical about the prospects of big gains from deregulation: US economic dynamism has waned, but the policies so far proposed in this area look potentially misdirected.
• ? Over the coming years asset market performance is unlikely to mirror that of the 1980s: valuations suggest less room for dollar appreciation and stock market gains this time around. But emerging market (EM) assets may do better – the soaring dollar and high US rates that hit EMs in the 1980s are unlikely to be repeated. And our analysis suggests even modestly better US growth will support commodity prices and EM growth.

     

Are central banks really breaking the (policy) rules?

• ? Looking at the strength of the global economy, it's no surprise that simple policy rules suggest that interest rates in some advanced economies are much too low and/or that several rate hikes would be needed in 2018 to avoid falling further behind the curve. Nonetheless, we expect central banks to respond cautiously and we see a slower pace of tightening than the consensus view .
• ? Policy rules, such as the Taylor Rule, have long been considered a useful guide to the potential path for policy rates. But while it suggests that current US, Eurozone and Australian central bank rates are broadly appropriate, it signals that UK, Canadian, and Swedish rates should be substantially higher. Based on our economic forecasts, Taylor Rules suggest that the central banks in the US, Eurozone, Canada and Australia will all need to raise intertest rates by around 100bps by end‐2018.
• ? However, there are several reasons not to draw strong conclusions from such point estimates. First, the Taylor Rule requires estimates of two unobservable variables – the output gap and the natural rate of interest – which cannot be estimated precisely.
• ? Second, using models that were designed to predict US policy responses in the 1990s to forecast central banks' behaviour today is likely to be misleading. Meanwhile, inferring central banks' reaction functions from recent policy rate moves to assess the future policy path is fraught with difficulties. Not only have interest rates been broadly unchanged for the bulk of the post‐financial crisis period, but policymakers have provided other forms of policy support.
• ? Third, outside the US at least, Taylor Rules have historically pointed to persistently different policy rates from those observed, yet inflation has been well anchored.
• ? The upshot of all this is that we expect central banks in the advanced economies to err on the side of caution and anticipate interest rates rising less quickly than the consensus amongst economists.

     

Market microstructure,banks’ behaviour and interbank spreads: evidence after the crisis

We present a study of the European electronic interbank market of overnight lending (e-MID) before and after the beginning of the financial crisis. The main goal of the paper is to explain the structural changes of lending/borrowing features due to the liquidity turmoil. Unlike previous contributions that focused on banks’ dependent and macro information as explanatory variables, we address the role of banks’ behaviour and market microstructure as determinants of the credit spreads. We show that all banks experienced significant variations in their liquidity costs due to the sensitivity of interbank rates to the timing and side of trades. We argue that, while larger banks did experience better funding conditions after the crisis, this was not just a consequence of the “too big to fail” perception of the market. Larger banks have been able to play more strategically when managing their liquidity by taking advantage of the changing market microstructure.

     

World Economic Prospects

Overview: Emerging sell‐off to restrain global growth

• Emerging financial markets have come under renewed downward pressure since mid‐January, with evidence of a general retreat by investors.
• There have been significant currency depreciations in several countries, and interest rates have been forced up in Turkey, India, South Africa and Brazil – with further hikes likely. Emerging stocks have plunged.
• This has prompted a sequence of downgrades to our growth forecasts for the emergers. We now expect Indian growth to be 0.2% lower this year than previously, South African growth 0.6% lower and Turkish growth 1.3% lower. In China and Brazil, growth in 2015 has been cut by around 0.5%.
• Weaker emerging growth will also constrain activity in the advanced economies. Emerging markets account for a modest share of advanced economy exports, but their share in export growth is higher. For the Eurozone, heavily dependent on external demand, this share has been 30–40% since 2010.
• Meanwhile, European listed firms get almost 25% of their revenues from emergers, and US firms 15% (while exports to emergers are 10% and 5% of GDP respectively). There has also been a sharp rise in bank loans to emergers in recent years.
• The biggest risks for global growth relate to China, which dwarfs the other emergers, and where concerns about possible financial instability, especially linked to shadow banking, have risen this year.
• Thanks to robust growth in the US, Japan and the UK, we still expect global growth to pick up in 2014, but downside risks have risen over the past month. With the US Fed set to press on with ‘tapering’ asset purchases, driving up global long‐term interest rates, emergers face potential further pressures.
• US tapering will be only partially offset by more expansionary monetary policy in Japan. What could make a big difference, and reduce the downside risks from emerging weakness, would be aggressive expansion in the Eurozone. At present, however, this seems unlikely – despite lingering deflation risks.