Is the world now heading for recession?
How coronavirus has affected our growth forecasts
Although we downgraded our outlook for global growth very recently, the deepening of the coronavirus outbreak has led us to re-assess our outlook for the world economy. The question now is not so much whether there will be a slowdown in growth, but whether the world economy is headed for a recession.
We had anticipated a further spread of the virus in our original forecast; however, we had not expected the whole of Italy to go into lockdown. When combined with the ongoing likelihood of the virus accelerating elsewhere and the increasing restrictions on public gatherings and travel plans, the downturn in Europe is likely to be deeper than previously expected. Consequently, we expect to cut our forecast for the eurozone by at least 1 percentage point and into negative territory for 2020, with weaker activity in Italy having a knock-on effect to the rest of the continent.
The UK will not be immune and weakness in the economy’s largest trading partner will be a headwind to growth in 2020. These changes alone would take our global growth forecast down to 2% from 2.3%.
Meanwhile, there is better news on China where the number of new cases appears to have peaked and high frequency indicators show the economy is gradually returning to normal. We are increasingly confident that the economy will recover further in Q2 before bouncing back in the second half of the year.
The US is still the world’s largest economy that accounts for over a quarter of global output. The introduction of travel restrictions and shutdowns would severely dent global growth. The good news is that the US economy faces the virus in robust health. Based on the first two months of the year, estimates suggest that GDP growth will hit 3% annualised in the first quarter. In practice, the figure is likely to be less than this as March is set to show a slowdown as the shutdown at Boeing takes its toll and overseas demand weakens as a result of the virus. The other factor is the collapse in the oil price.
Policy measures: building a bridge
Central banks have reacted rapidly to the crisis, with the US Federal Reserve (Fed) cutting rates by 50 basis points on 3 March and the Bank of England following suit on 11 March. Rates have also fallen in Australia, Canada and China. Alongside the reduction in bank rate, the Bank of England announced a new programme to incentivise banks to lend to small and medium sized enterprises (term funding for SMEs). These measures, alongside those announced in the UK budget are designed to ensure that there is sufficient support to bridge firms over the crisis.
Action by the European Central Bank is in the same vein, although they did not cut rates measures were introduced to boost bank lending to SME’s alongside an increase in asset purchases.
The US may take a more direct approach by bailing out the airline sector in the same way as autos received support in 2009. It is also likely that we see a broader fiscal package including a cut in payroll taxes to support the economy. Meanwhile, the Fed can be expected to cut rates further, by probably another 50 basis points. There is also a case for an expansion of the QE programme to include purchases of corporate bonds.
Looking ahead, we would be looking for a deeper downturn in global activity as a result of recent developments. It is quite likely that this tips the world economy, which we have described as a wobbly bike due to its slow pace of activity, into recession.
Our expectations for US growth are already low at 1.6% for 2020, but US recession would mean global recession.
Central banks have moved quickly and should be able to provide the basis for a recovery later in 2020.
In many ways the world economy is better placed to cope with such shocks than in 2008: the central banks have developed new tools and the banking system is well capitalised. Investors are now looking for action on the fiscal front.
However, the situation develops rapidly. Monetary and fiscal tools are weak in the face of the virus and until the outbreak is under control the tail risk of a prolonged slump remains high.
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