We expect the global economy to expand by only 2.2% at market exchange rates in 2012, and by 3.1% at purchasing power parity (PPP) rates. Although next year will be better, we forecast a recovery only to 2.5% and 3.5%. The euro zone will expand fractionally in 2013, after contracting this year, and China will benefit from easier monetary conditions, stronger loan growth and faster project approvals. The US will be supported by the Federal Reserve's unprecedented level of monetary easing. None of this will, however, amount to a strong expansion.
The euro zone debt crisis remains the greatest risk to the global economy, although the European Central Bank (ECB)'s new funding program for struggling countries on the periphery has been an important step in easing funding pressures on the periphery and improving market sentiment. The bank's goal, outlined by the ECB's president, Mario Draghi, is to restore smooth functioning to euro zone monetary policy by removing the "tail risk" of a euro zone break-up. The ECB will therefore intervene as often, and for as long, as necessary to achieve this goal. Importantly, the ECB gave up its previous insistence that its claims should subordinate those of private creditors.
But the OMT program will only be activated if countries first request support from the European Stability Mechanism (ESM) and submit to a package of fiscal targets that will be enforced by the "troika" of the ECB, EU and IMF. Spain, the large country most clearly in need of help, has been reluctant to apply for financial support, although it appears that it may do so shortly. Italy is in a better position because its net external asset position is much stronger and we assume that it will get by without official support.
While OMT program is succeeding in lowering borrowing costs for stressed sovereigns, agreement among politicians and policymakers on moves towards fiscal and bank integration remains elusive. Such measures encompass the issuance of jointly and severally guaranteed Eurobonds and a euro zone system of banking regulation (including deposit guarantees). Germany and other core countries are hesitant to commit to such initiatives out of fear that they will be exposed to an open-ended financial cost.
Meanwhile, peripheral countries which lost competitiveness relative to the core during the first decade of monetary union face a long grind to reverse this process through wage suppression and gains in productivity which will be all the harder to achieve at a period when banks are shrinking their balance-sheets.
For the US the Economist Intelligence Unit forecasts growth of only 2.1% in 2012. In light of the sluggish performance of the economy, the Federal Reserve has announced a larger- than-expected third round of quantitative easing (giving an open-ended commitment to buy US$40bn of mortgage-backed securities each month). The Fed also extended to mid-2015 the period over which it pledges to keep its policy rate at exceptionally low levels. In a new departure, the Fed explicitly tied its latest QE program to the weak labor market: it will keep buying bonds until the jobs picture improves. It is not clear if this will work: while earlier rounds of QE boosted asset prices and depressed the dollar, their impact on the real economy was questionable.
The injection of more monetary stimulus into the US economy can be seen as an insurance policy against the risk posed by a so-called "fiscal cliff" which the US faces at the start of 2013 when deep spending cuts and tax increases equivalent to a fiscal tightening of around US$400bn (2.7% of GDP) are scheduled to kick in. Our 2013 growth forecast of 2.1% assumes that the incoming government reaches agreement with Congress on scaling back or delaying some of the spending cuts and tax rises. If agreement proves elusive, the US would go into recession in 2013.
Owing to their stronger financial positions, emerging markets will again outperform again in 2012-13, although they will feel a draught from sluggish demand in the West. China will be crucial in determining the performance emerging markets, given its importance as a trading partner and as a source of demand for commodities. In 2009 the Chinese authorities managed to offset weakness in export markets by policies to stimulate property and infrastructure. But these policies exacerbated imbalances in the economy (reflected in a high rate of investment in fixed assets relative to GDP) and inflated a property bubble (in high-range properties in coastal cities). This legacy from the last stimulus program is making the Chinese authorities cautious in their response to the current slowdown.
We retain the view that China will avoid a hard landing. The official PMI for September may indicate that the bottom of the cycle is now past and that monetary and fiscal stimulus measures are starting to take effect.
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