World Economic Prospects

Overview: Global deflation – a genuine risk?

• The notable decline in inflation in the Eurozone, US and UK since mid-2013 has led to suggestions that a period of widespread price deflation across the major economies is a risk. Adding to these concerns has been the trajectory of producer prices – already declining in the Eurozone and China and showing very subdued growth elsewhere.
• Our global GDP forecasts do not, in isolation, point to a worldwide deflation risk. We expect growth at 2.8% this year and 3.2% next, little changed from last month.
• But the starting point for this growth matters, specifically the gap between actual and potential output last year. Even with reasonable growth, an initially large output gap would imply downward pressure on inflation over the next two years.
• Unfortunately, the size of the output gap is very uncertain. There is a wide range of estimates for the major economies, especially Japan. Part of the problem is that it is hard to know how much potential output was (or was not) permanently lost during the global financial crisis and recession.
• Assuming substantial permanent losses, output gaps might be relatively modest now, but a more optimistic view of the supply side of the economy would suggest output gaps could be quite large – and arguably this fits better with the recent evidence from inflation.
• Overall, while we see a genuine risk of deflation in the Eurozone (with around a 15% probability) we are more upbeat about the other major economies, where growth in the broad money supply and nominal GDP do not seem to be signaling deflation risks.
• But the difficulty of measuring ‘slack’ in the economy for us underlines the case for central banks to err on the side of caution when setting monetary policy, and either not tightening too soon or easing further. This month we have built in a further ECB rate cut to our Eurozone forecast. In Japan, we have revised down growth for 2014–15 with recent data strengthening the case for additional monetary easing this year.

     

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.

     

World Economic Prospects

Overview: Dollar surge brings mixed consequences

• The strengthening dollar is now becoming a significant factor for global growth and our forecasts. The tradeweighted dollar is up 2.5% over the last month and over 12% on a year ago.
• Driving the latest rise are growing expectations of US rate hikes while monetary policy in many other major economies is headed in the opposite direction.
• The beginning of ECB QE has prompted a further slide in bond yields and the euro – which at 1.06/US$ is on course to fulfill our forecast of near‐parity by year‐end. Weak data in Japan also raises the chance of a further expansion of QE there later this year.
• We remain relatively positive about the advanced economies: we forecast G7 GDP growth at 2.2% for 2015 and 2.3% next. This month we have revised up German growth for 2015 to 2.4% – a four‐year high.
• Robust US growth and a strong dollar are good news for the advanced economies. US import volume growth firmed to over 5% on the year in January, while the dollar surge potentially boosts the share of other advanced countries in this growing market.
• But for the emerging economies the picture is mixed. A stronger US may boost exports, but rising US rates are pulling capital away: there has been a slump in portfolio inflows into emergers in recent months. Emerging growth may also suffer from higher costs of dollar funding and a rising burden of dollar debt as currencies soften – the more so if US rates rise faster than markets expect.
• Moreover, emergers are also under pressure from a slowing China. Chinese import growth has been weak of late and commodity prices remain under downward pressure. A notable casualty has been Brazil, which we have downgraded again this month – GDP is expected to slump 1.1% this year.
• Emerging GDP growth overall is expected to slip to 3.7% this year, the lowest since 2009. And excluding China, emerging growth will be only 2.2% – the same as the G7 and the worst performance relative to the advanced economies since 1999.

     

World Economic Prospects

Overview: A world with higher inflation

• Our world GDP growth forecasts are unchanged this month, at 2.6% for 2017 and 2.9% in 2018. But we expect a sizeable increase in inflation, to 3.3% in 2017 from an estimated 2.8% in 2016, as the effect of higher oil prices feeds through.
• Global indicators continue to point to a pick‐up in activity towards the end of last year, driven by stronger manufacturing activity. The global manufacturing PMI rose to the highest level in almost three years in December, while the composite index – which includes services – was at a 13‐month high.
• World trade should be underpinned by stronger growth in the US (2.3% in 2017 and 2.5% in 2018), bolstered by the anticipated effects of President Trump's expansive fiscal policies. That said, uncertainties around our central forecast are unusually high given the high level of uncertainty surrounding the Trump administration. Encouragingly, there are increasing signs that the tighter labour market is leading to a pick‐up in wage inflation in the US, which will support consumers.
• Given these reflationary trends, we expect two increases in the Federal funds rate this year and US bond yields are likely to continue to rise. The widening of interest rate differentials between the US and the Eurozone will drive the euro down to parity with the US dollar by end‐2017 for the first time since 2002.
• We have revised our Brexit assumptions this month. We now assume that the two‐year period of exit negotiations is followed by a transitional arrangement lasting 2–3 years. This would provide breathing space to negotiate a free trade agreement with the EU.
• Emerging market growth on the whole will improve in 2017 but performance will differ across countries: Russia and Brazil will exit recession, but countries with weak balance of payments positions, high dollar debt and exposure to possible US protectionist actions will be at risk. In China, policymakers are moving to greater emphasis on reducing financial risks and less focus on the 6.5% GDP growth target for 2017. Continued action is also likely to dampen further depreciation of the CNY.

     

World Economic Prospects

Overview: Are we entering another global ‘soft patch’?

• Global growth has tended to hit ‘soft patches’ at the start of recent years and some indicators are again pointing in that direction at present.
• In the US, we expect GDP growth at around 2% annualised in Q1 based on recent indicators which have included subdued jobs growth and some slowdown in housing.
• Meanwhile, the latest readings for the export orders components of key manufacturing surveys – which are good predictors of world trade growth – suggest some pullback after a modest upturn in the final months of 2013. Trade growth remains especially subdued in Asia, including Japan and China.
• The crisis in Ukraine also poses some downside risks, should it escalate further – in particular the danger of a sharp rise in European gas prices which could harm the still fragile Eurozone economy.
• Overall, we regard most of these factors as temporary and continue to forecast a strengthening global economy over the coming 18 months. US data at the start of this year have been partly dampened by climatic factors, while underlying domestic demand growth in Japan remains robust and the Eurozone outlook has continued to improve slowly.
• As a result, our world GDP growth forecasts are little changed from last month, at 2.8% for 2014 and 3.2% for 2015.
• This forecast is partly underpinned by a renewed pickup in world trade. But there are some risks to this assumption, including the possibility that emerging market countries will have to rapidly improve their current account positions due to the more restrictive external financing conditions associated with US tapering.
• Such an adjustment could put a significant dent in our forecast for world trade growth. For ten large emergers, shifting current account balances to our estimates of their sustainable levels would mean an adjustment of around US$280 billion – around 40% of the increment to world trade that we forecast for 2014.

     

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.