Talking Economics - February 2015
An acceleration in the advanced economies is offset by weaker growth in the emerging markets (EM) to leave our global growth forecast at 2.8% in 2015.
- An acceleration in the advanced economies is offset by weaker growth in the emerging markets (EM) to leave our global growth forecast at 2.8% in 2015.
- Inflation in the advanced world is expected to record its lowest rate for five years in 2015, but picks up in 2016 as the impact of lower energy prices fades. We do not expect sustained deflation in the eurozone or in the wider global economy.
- It is a sea of green in Europe as we upgrade our growth forecast across the board. Lower energy prices, a weaker euro, stronger banks and European Central Bank (ECB) quantitative easing (QE) should all help lift European growth in 2015 and 2016. Our UK forecast has also been raised, but the economy is on a slowing trend. Lower energy prices will help provide a soft landing.
- Oil’s decline has a mixed impact on the BRIC economies, with Russia an obvious loser. While we see inflation falling in India and China, the growth benefit is limited, and Brazil’s faces a myriad of domestic problems. Meanwhile, the Federal Reserve (Fed) interest rate hike looms and emerging markets still look vulnerable.
Forecast update: Global tilt toward advanced economies
An increase in our growth projection for the advanced economies is offset by a cut to the emerging markets' outlook to leave our global forecast at 2.8% year on year (y/y) for 2015. The former are expected to pick up to 2.2% y/y this year (up 0.5% on 2014), with US growth expected to reach 3.2% y/y (previously 2.8%), the best performance since 2005. We have raised our forecasts for the eurozone and Japan by just under 0.5% for 2015 to 1.3% and 1.6% y/y respectively. However, emerging markets growth is expected to slow to 3.7% from 4.2%.
For 2016, US growth is expected to moderate as the boost from oil fades and higher interest rates and a stronger dollar begin to weigh on growth. However, the overall global growth forecast ticks up to 3% next year on further improvement in Europe and Japan as well as continued strength from India.
Low inflation keeps monetary policy loose
Our inflation forecasts have been cut in response to lower-than-expected outturns recently and further falls in energy prices. Global inflation is expected at 2.5% for 2015 (2.8% in 2014). The decline would have been greater but for a pickup in emerging market inflation from 5.1% to 5.9% (largely driven by an expected surge in Russian inflation). We expect a significant reduction for the advanced economies to 0.5% from 1.4%. Importantly, we see inflation picking up again in 2016, dispelling deflation fears, as the effect of lower oil prices fades.
In the meantime, low inflation can keep monetary policy on hold or loose. The exception, in our view, is still the US. The Fed is still expected to look through the fall in headline inflation and focus on a stable core rate of inflation and tightening labour market so as to raise rates in 2015. We expect the Fed funds rate to rise to 1.25% by end 2015 and then peak at 2.5% in 2016.
Scenarios: Still leaning towards deflation
We have refreshed our scenario analysis. Although the balance of risk still tilts toward deflation, the probability of that outcome is lower at 15%. We have removed "JPY collapses" (better growth means less pressure on the Bank of Japan to keep printing money), "capacity limits bite" (seems distant from a global perspective) and "productivity recovers" (US data suggests otherwise). In come "oil lower for longer" (oil price falls to, and stays at, $30 per barrel), "secular stagnation" (global activity grinds structurally lower) and "eurozone abandons austerity" (to head off a political backlash). The "eurozone deflation" scenario has become a more severe "eurozone deflationary spiral" (where the economy falls into a major slump from which it is hard to escape). Despite the recent ceasefire, the "Russian rumble" (where conflict in the Ukraine culminates in the cut off of energy supplies to Europe) remains one of the greater individual risks.
European forecast update: Upgrades all round
Recovery resumes as political risk subsides
Eurozone growth accelerated at the end of 2014 as the region appeared to shake off Ukraine/Russia concerns. Another fading source of political risk is the latest Greek crisis. At the time of writing, Greece had just had its current bailout extended for four more months. The crisis will likely return after this deadline but the risk of economic or financial contagion is small, given the relative size of the economy and because the European financial sector has largely either disposed of or written off its exposure to the economy.
A sea of green – upgrades all round
For the eurozone in aggregate, we have raised our forecast from 0.9% to 1.3% for 2015 (consensus expects 1.2%). For 2016, we have raised the forecast from 1.4% to 1.6% (against a consensus of 1.7%). Four key tailwinds contribute to a stronger outlook across Europe over the forecast horizon: a lower oil price (benefits households and businesses); ongoing euro weakness (helps the competitiveness of exporters and domestic producers, and boosts earnings for European-listed companies); increased banking activity (following the ECB's asset quality review) and lower interest rates (as a result of the launch of QE).
Inflation is likely to remain negative for the next few months, but the oil price effect will likely begin to unwind by the end of the year. We have lowered the forecast from 0.8% to 0.1% for this year, versus a consensus of -0.1%, while for 2016, we expect a rise to 1.2% from 1.1% (consensus expects 1.1%). Our forecast for the ECB is largely unchanged: we do not expect any changes to interest rates for the foreseeable future and expect QE to be in place at the stated pace of €60 billion per month until September 2016.
UK upgraded, but slowdown still coming
The UK will also benefit from the falls in energy prices and this has led us to raise our forecast for 2015 GDP to 2.6%. However, we expect growth to slow to 2% in 2016 on the back of weaker investment and the fiscal tightening that will result after May's election. Regarding inflation, we expect headline Consumer Price Index (CPI) inflation to be near zero for the coming few months, but to rise from the summer given that our analysis suggests there is a lack a spare capacity in the economy. We therefore continue to expect the Bank of England to start normalising monetary policy at the end of this year. We expect one 25 basis point hike in November, followed by three more such hikes in 2016.
EM forecast update: Oil on troubled waters or fuel for the fire?
Concerns have been building recently about EM vulnerabilities in the event of a Fed rate rise. The danger is that a hike, particularly if it comes earlier than the market expects, could trigger EM corporate defaults and economic slowdown, if not crisis. We do not believe the summer will see a 1998-style EM-wide crisis, but certain countries (e.g. Turkey and South Africa) are at particular risk.
China – oil eases the path of reform
The growth outlook for China is unchanged (6.8% in 2015 and 6.5% in 2016) as we do not believe the economy will reap the full benefits of lower oil prices. Instead, we expect the government to use the oil price falls to reduce subsidies. We have lowered our inflation forecasts given a combination of oil price profile, economic overcapacity and moderating domestic demand. We continue to expect monetary easing in the form of cuts to the reserve requirement ratio (RRR).
Brazil – something is rotten in the state of Rio
We have downgraded our growth outlook for Brazil on the back of the growing Petrobras scandal and greater-than-expected fiscal consolidation plans. There is also a downside risk posed by possible water shortages (Brazil is suffering its worst drought in 80 years), which could prompt electricity rationing. Meanwhile, we have increased our 2015 inflation forecast due to the one-off impact of electricity tariff increases and pass-through from the continuing currency weakness. We expect further rate hikes from the central bank before the current cycle comes to an end, but then believe we could see cuts in the second half of the year as growth sours markedly.
India – waiting for reform
A significant upward revision to growth sees India outpacing China in economic growth – Modi works fast! Sadly though, this is the result of a change in GDP calculation rather than due to a raft of successful reforms, which have so far been lacking (although sentiment remains positive). Investment growth remains weak, and it will take a real, rather than accounting, change to remedy this situation.
Oil has also helped drive down inflation and we expect interest rates to fall to 7% by the third quarter.
Russia – oil creates a slippery slope
A weaker oil price is, unsurprisingly, bad news for Russia. As well as contributing to currency weakness and a worsening current account position, it reduces the scope for fiscal support for the economy. 2014's budget assumed a $114 per barrel price – 2015 will have to see substantial cutbacks. Combined with sanctions and still high tensions in Ukraine, we have turned more negative on the country's growth outlook, particularly in light of the move in the oil price since we last published our forecasts. We now expect GDP to contract by 4.9% in 2015 and by 0.4% in 2016 with inflation higher at 13.4% in 2015.
Talking Economics is based on Schroders Economic and Strategy Viewpoint, produced by the Schroders Economics Team: Keith Wade, Chief Economist, Azad Zangana, European Economist, and Craig Botham, Emerging Markets Economist.
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