March 2014

Global growth on track, but downside risks have increased (page 2)
  • Recent data suggests that the US economy will rebound in coming months following firmer readings for employment, retail sales and industrial production. Growth indicators for the UK, Eurozone and Japan remain firm, but the emerging markets continue to struggle. Our central view is on track, but our principal concern this month is that downside tail risks have increased. 
  • Eurozone deflation is one of our risk scenarios and one where the probability is increasing judging from the deflation vulnerability indicator (see chart). We fear that the European Central Bank (ECB) may be repeating the mistakes of the Bank of Japan in the 1990’s when the economy unexpectedly slipped into deflation. Downside risks could be compounded by the crisis in the Ukraine where there is a real threat of higher energy prices. We see the situation evolving into a prolonged stand-off with damaging effects on European business and consumer confidence and a drying up of foreign investment into Russia. 

Rising risk of European deflation (page 7)
  • Low inflation in the Eurozone is becoming a serious risk that could lead to outright deflation. We have recreated the IMF’s deflation vulnerability index which suggests that risk is now ‘high’ for the Eurozone in aggregate (chart).
  • While our central view is that Europe will not experience a Japanese-style episode as recovery continues, we cannot ignore the warning signs that the risk of deflation is escalating. Deflation or even prolonged very low inflation could cause many governments’ balance sheets to become unsustainable. The tail risk is growing, but is the ECB paying attention?

China – Not such a happy New Year (page 13)
  • The New Year hasn’t brought much in the way of cheer for China. Activity data points to an economic slowdown on most fronts which could prove challenging to a government trying to rebalance. We don’t expect a credit stimulus but China seems set for accelerated fiscal outlays.

Views at a glance (page 17 )
  • A short summary of our macro views and the risks to the world economy.