Global forecast update and scenarios
Global activity undershot expectations in 2014 but we expect a modest recovery in 2015 and 2016. Monetary policy is set to diverge with the US and UK tightening whilst policy is expected to remain loose in the eurozone and Japan.
Risks are still skewed toward more deflationary outcomes, however, we have also increased the probability on a stronger growth and lower inflation outcome to reflect the ongoing fall in energy costs.
Global growth and inflation have been lower than expected during 2014 with most of the growth disappointment attributable to the emerging markets. Looking ahead, our global growth forecast of 2.8% for 2015 is little changed from last quarter, with downward revisions to the eurozone and emerging markets offset by upward adjustments to the US and Japan. This compares with a likely outcome of 2.6% in 2014. Upgrades in the US and Japan reflect the benefits of lower oil prices and an absence of fiscal tightening, while in the eurozone and emerging economies, these positives are offset by structural headwinds on growth.
Our analysis indicates that risks are skewed towards deflation even more so than last quarter.
Meanwhile, our estimate for 2016 shows another year of sub-par global growth at 2.8%, with US activity moderating in response to higher interest rates and a stronger US dollar. Growth in China is also likely to ease and, when combined with the US, would offset minor upturns in Japan and the eurozone in response to further monetary policy easing and currency depreciation.
Our inflation forecasts have been cut in response to lower-than-expected outturns in recent months and the fall in commodity prices. Global inflation is expected to come in at 2.9% for 2015 with a significant reduction for the US, where falling energy prices have the most impact on CPI inflation.
We have reduced our estimate of the pace of rate tightening such that we expect the Fed funds rate to rise to 1.25% by end 2015 (previously 1.5%), peaking at 2.5% in 2016. In Europe, we expect the European Central Bank to implement full quantitative easing later in 2015 and have pushed out the first UK rate hike to November 2015 (previously February) as a result of lower inflation. Elsewhere, the Bank of Japan (BoJ) is likely to let the weaker yen support the economy and refrain from further increases in QQE (qualitative and quantitative easing). Meanwhile, China is expected to cut interest rates further and pursue other means of stimulating activity in selected sectors.
Our analysis indicates that risks are skewed towards deflation even more so than last quarter given the possibility of "Eurozone deflation", "China hard landing" and "JPY collapse". The new scenario, "JPY collapse", would occur if investors question whether the Japanese government is serious about debt reduction as it continues to delay tax hikes. Capital flight would follow on fears of default and the BoJ would be forced to raise interest rates, resulting in a very weak yen and higher risk premiums in global bond markets, thus creating a deflationary impulse for the rest of the world. The probability on "G7 boom" has been slightly reduced to reflect the lack of traction from monetary policy to growth in the eurozone and Japan. However, we have increased the probability on "productivity growth boost" to capture the risk that the fall in oil prices will lift growth by more than expected. Overall, our analysis continues to suggest that central banks are likely to maintain stimulus in the face of a lower inflation outcome than in the baseline.