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World Growth Slows as Europe Stagnates
The further deterioration in the economic and financial situation in the Euro area has led us to
downgrade our global GDP forecast significantly, from 4.3% to 3.5% in 2012. Over the next
few quarters, we now expect a mild recession in Germany and France, and a deeper downturn
in the Euro periphery. The increase in financial risk is likely to lead the European Central Bank
to ease its liquidity policies further this month, and the economic weakness will probably result
in a cut in the repo rate by 50bp to 1% by December.
The increase in spillovers from the Euro area, primarily via tighter financial condition, is the
primary reason why we have also downgraded our forecasts for the US further. We now see the
risk of a renewed US recession as around 40%. We expect additional easing of monetary policy
beyond the ‘operation twist’ announced recently, although this may not come until sometime in
the first half of 2012. In addition, the market’s focus on changes in the Fed’s guidance on future
policies - including a greater emphasis on the employment part of the ‘dual mandate’ and/or a
temporarily higher inflation target - is likely to intensify.
Despite the deterioration in the advanced economies, Table 1 shows that our baseline global
growth forecast for 2012 remains at 3.5%—a downgrade of 0.8ppt from our prior forecast and
well below the pace seen in 2010-2011, but still decent by historical standards. The main reason
is that we expect only a modest slowdown in China and other emerging economies. Although
the recent Chinese policy tightening and the downturn in export demand are likely to weigh on
growth in the next few quarters, we expect the waning inflationary pressures to lead to a
renewed easing of policy later this year, and this should underpin a moderate reacceleration in
2012.
The downgrade to our growth forecasts has led us to lower our targets for bond yields,
commodity prices and equity prices. While even the new targets are generally above the
forwards, the downside ‘skew’ to our market views has increased notably.
The Euro Crisis Intensifies
On account of the intensifying financial dislocations in Europe, we have substantially revised
down our outlook for economic activity in the Euro area over the next two years. The Euro area
economy entered the year strongly, with first-quarter growth of 0.8%qoq, or 3.1% at an annual
rate. A slowdown from this strength was expected, but the weakness in official and survey data
through mid-year has gone further than we expected. The new forecasts embody significant
downward revisions to Euro area growth for both 2011 and 2012. Our projections for year-onyear
growth rates in 2011 and 2012 are 1.7% and 0.1% respectively, with a recession—defined
as two successive quarters of negative growth—foreseen at the turn of the year.
On this basis, we expect inflation to moderate further in
the first half of 2012, giving the ECB ample room to
lower policy rates. We see the ECB lowering its repo rate
by 50bp in December, with the risk that a cut may come
earlier. With rates likely on hold in October, we think that
the ECB will focus its immediate attention on bolstering
its non-standard policy measures, aimed at supporting
bank funding and peripheral sovereign debt markets
where the current tensions are most acute. Given the
current market situation, there seems to be little prospect
of the ECB withdrawing significantly from these nonstandard
measures over the forecast horizon.
The rationale for our downward revisions varies across
countries. Alongside a recession in the short term and
stagnation next year, our new growth projections imply
additional intra-Euro area cross-country divergence. We
assume that financial dislocation in the periphery will
persist into 2012, compounding the effects of fiscal
consolidation on growth. We therefore project a more
persistent downturn in peripheral countries. The impact of
financial tension is less severe in most core countries,
with sovereign yields low and corporate balance sheets
strong. Nevertheless, the outlook for economic activity in
the core has also deteriorated, on account of the expected
weakness of demand from peripheral countries in
recession and, at least temporarily, by decisions to delay
investment in the face of elevated uncertainty stemming
from financial market developments.
Will the US Avoid Recession?
We have downgraded our US GDP forecast for 2012 to
1.4% from 2.0%, and now see growth bottoming at ½%
(annualised) in the first quarter of 2012. The reason for
our downgrade is the larger financial and economic shock
from the deterioration in the Euro area. We believe that
this could take around 1ppt off US growth over the next
year (although a small portion of this hit was already
included in our prior forecasts.) There are three main
channels of transmission:
A tightening of financial conditions as measured by
our GS financial conditions index, which we expect to
take about ½ percentage point off GDP growth over
the next year.
Decreased availability of credit, which could take up to
½ percentage point off GDP growth, although there is
not yet much evidence of a negative effect.
Real economy spillovers via reduced exports (both to
the Euro area and third countries), which might take
another 10bp off growth. (For more details, see
Andrew Tilton, “Will the European Storm Cross the
Atlantic?” US Economics Analyst, 11/37, 2011.)
The obvious risk is that this hit will accelerate the labour
market deterioration that is already underway, and will
thereby push the economy into recession via the ‘stall
speed’ effects that we have long noted. Indeed, our
forecast now calls for a (very gradual) increase in the
unemployment rate from a trough of 8.9% in early 2011
to 9.5% in late 2012. If this comes without an outright
recession, it would be the first time in postwar history that
the unemployment rate has risen more than 35 basis
points without an outright recession.
However, we believe that the expansion might be
somewhat less vulnerable to rising unemployment than it
has been in prior cycles. The main reason for this is that
the most cyclical sectors of the economy, such as
homebuilding, durable consumption, business investment
and inventories—which typically account for all of the
decline in overall real GDP in recessions—are already at
very low levels of activity and are unlikely to decline
dramatically further unless there is another very large
shock. (See Zach Pandl, “How Much Downside?” US
Economics Analyst, 11/39, September 30, 2011.) We
therefore believe that the risk of recession is ‘only’ 40%
despite the upward trend in the unemployment rate.
Moreover, if there is indeed a recession, we suspect it
would be relatively ‘mild’ for the same reason. (The term
‘mild’ is in quotation marks because it refers only to the
rate of change of activity and employment, recognising
that the levels are already unacceptably low.)
Whether or not the economy enters another recession, a
meaningfully above-trend recovery looks quite unlikely.
A key reason for this is that monetary and fiscal policy is
much less likely to make a positive contribution than in
past cycles. In fact, we expect fiscal policy at the federal,
state and local level to subtract about ¾ percentage point
from growth next year, even assuming that Congress
extends the 2011 payroll tax cut by another year and adds
a hiring tax credit for small firms. On the monetary policy
side, some additional easing is likely, and we expect a
return to quantitative easing—defined as the financing of
large-scale asset purchases by the creation of excess
reserves—in addition to the recent ‘operation twist’ either
later this year or in the first half of 2012. Moreover, the
recent discussion about potential changes in the
interpretation of the Fed’s dual mandate is likely to
continue. But, on balance, we do not expect a big positive
impulse from the policy side anytime soon.
Will China Keep Supporting Global Growth?
The stalling of economic activity in Europe and the US
has further increased the importance of continued
expansion in the emerging world—especially China—for
the global growth picture. It is admittedly easy to worry
about China’s resilience. For one thing, China is quite
vulnerable to slower growth in its major export markets -
as it is such an export-driven economy. We estimate that
a slowdown in world GDP growth (ex China) results in
about a 1-for-1 hit to Chinese growth, a much bigger
number than in any other major economy.
In addition, Chinese policymakers have tightened
aggressively in recent months, mainly via more stringent
loan guidance to the banks. The reason for this hawkish
policy stance is twofold. First, inflation has stayed higher
for longer than we expected. The main culprit is the surge
in food prices, which have risen 13.4% over the last year
and show only tentative signs of peaking in sequential
terms. Second, the sharp increase in overall leverage in
the Chinese economy—mostly in the local government
sector—has probably made Chinese authorities more
reluctant to respond to a deteriorating economic outlook
by easing policy as early as they did in 2011.
But while the external drag and the policy tightening are
likely to keep growth below trend in the near term, we do
expect a modest reacceleration in 2012. At the most basic
level, we do not believe that China is a ‘bubble economy’.
And while inflation has stayed higher for longer, we still
expect it to come down significantly in coming months,
with the headline CPI down to around 4% by November
from 6.2% in August. Combined with the slowdown in
global activity, this is likely to prompt Chinese
policymakers to ease policy anew, which should boost
growth with a relatively short lag.
Outside China, we have also cut our growth forecasts
across the bulk of the Asian and Latin American
economies and made further downward adjustments to
our EMEA forecasts.
A More Unfriendly Asset Market Environment
We have also adjusted our asset market forecasts,
although less dramatically. In particular, we now see:
Lower bond yields. Reflecting the shift in growth and
policy rates, we have lowered our bond yield profile
across the major markets. Those forecasts are now
around 75bp lower for German and US bond yields.
Given what are already quite stretched valuations,
however, we still find it hard to generate forecasts for
lower yields than current market prices without a
broader shift into recession across the major markets.
In EM, we are also forecasting more easing in Brazil
and shifting to forecast rate cuts in Mexico and Chile.
Lower equity index targets, with more pressure in
Europe in the near term. With the shifts in growth
views, our Portfolio Strategy teams’ earnings forecasts
have also come down, particularly in Europe where we
now forecast negative earnings growth in 2012, well
below the consensus. Our revised targets still look for
significant gains over 12 months in equity markets in
our central case, but with low conviction on the nearterm,
particularly in Europe (see Strategy Matters:
Risks deepen, stocks cheapen, also published today).
A bit less Dollar weakening. Our mid-September
issue of The Global FX Monthly Analyst already
acknowledged some of the forces that have driven this
latest round of economic revisions, and we cut our
EUR/$ forecasts there, alongside some EM currency
forecasts. We have made a further modest adjustment
now, and given weaker global growth are also taking
down our AUD and NZD profiles and forecasting a
weaker path for the BRL given a weaker balance of
payments outlook. But with a Fed still firmly in easing
mode, markets pricing more rate cuts than we expect in
most non-US markets, and a still-heavy US funding
requirement, we still controversially show Dollar
weakness persisting in the medium term.
A flatter upward trajectory for commodities, but
increasing risks to both the up and downside. The
weaker global growth path translates into weaker
global commodity demand but with our revisions
falling hardest on European growth and our EM
growth profile still relatively solid, our central
economic view is still one that generates enough
demand to continue to tighten the major commodity
markets. As a result, our Commodities team now sees
Brent crude prices ending this year at $112.5/bbl
(previously $119.50) and ending 2012 at $122.5/bbl
(previously $138.50), while we are pushing out the
timing of a tight copper market and lower our 12-
month price forecast from $11,000/mt to $9,500/mt.
While we recognise the downside risk to our forecast
from a potential European financial crisis, we also
believe it is important to recognise that an event so
widely anticipated will likely have an impact if it does
not occur. The oil market continues to destock as
prices anticipate a potential crisis. If the crisis does not
occur, the oil market risks running into pressing supply
constraints, requiring sharply higher prices than we
currently forecast to force demand in line with
supplies.
The question is why we are not shifting these forecasts
more. Even after revisions, they still leave us—in our
central case at least—bearish on the Dollar, bearish on
rates and bullish on commodities and equities.
The answer is that our central forecast path is still one
that looks more benign on average than the market is
pricing. We have argued for some time that US rates
markets and cyclical equities are pricing something close
to a mild recession already; our view of the ECB, while
now incorporating rate cuts, is still more hawkish than the
forwards, reflecting our belief that the ECB still has a bias
towards unconventional over conventional tools to deal
with the periphery’s economic crisis; and without a
sharper demand slowdown in China/EM than in our
central case, we see commodity supply tightness still
becoming a binding constraint.
But the market outlook continues to be complicated by
the fact that many markets are priced for a scenario that is
significantly worse than our central case—albeit still
arguably better than a full global recession. In that sense,
clichéd though it now is, the world remains essentially
somewhat ‘bimodal’. Until we can be confident that the
markets will be able to choose decisively in favour of one
of these, we are likely to see a continuation of the high
volatility that we have seen lately.
Because of that, as at other times of deteriorating
economic momentum, we think it is dangerous to lean too
heavily on point forecasts of asset markets. In this more
fluid environment, we have emphasised instead the
conditions for markets to manage a sustained
improvement of the kind consistent with our central
forecasts. In particular, we have emphasised that three
sources of pressure—deteriorating data, tightening
financial conditions and intensifying banking stresses—
will likely need to reverse before markets can sustain an
improvement. Until we see those conditions—and as yet
we have not—we think it makes sense to take a cautious
view of asset markets. Stability of some kind in these
areas is certainly consistent with our revised economic
forecasts, but in practice the point at which we may see it
is hard to determine with much precision.
We are also watching carefully for any cracks in one of
the most critical assumptions in our current outlook: the
notion that financial transmission to the EM world will be
limited. If economic pressures broaden, it is that
assumption—and with it the outlook for commodities,
and to some degree the Dollar—that will be most
vulnerable. But if our central forecasts are closer to
reality, then markets could relax significantly at the point
where it becomes clearer that the threats are receding. We
still see it likely that policy will play a major role in
determining which of these outcomes dominates. A more
rapid shift towards conventional policy easing in Europe,
China and beyond and a quicker shift towards a
comprehensive recapitalisation plan for Euro area banks
would all be helpful on that front.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
World Growth Slows as Europe Stagnates
The further deterioration in the economic and financial situation in the Euro area has led us to
downgrade our global GDP forecast significantly, from 4.3% to 3.5% in 2012. Over the next
few quarters, we now expect a mild recession in Germany and France, and a deeper downturn
in the Euro periphery. The increase in financial risk is likely to lead the European Central Bank
to ease its liquidity policies further this month, and the economic weakness will probably result
in a cut in the repo rate by 50bp to 1% by December.
The increase in spillovers from the Euro area, primarily via tighter financial condition, is the
primary reason why we have also downgraded our forecasts for the US further. We now see the
risk of a renewed US recession as around 40%. We expect additional easing of monetary policy
beyond the ‘operation twist’ announced recently, although this may not come until sometime in
the first half of 2012. In addition, the market’s focus on changes in the Fed’s guidance on future
policies - including a greater emphasis on the employment part of the ‘dual mandate’ and/or a
temporarily higher inflation target - is likely to intensify.
Despite the deterioration in the advanced economies, Table 1 shows that our baseline global
growth forecast for 2012 remains at 3.5%—a downgrade of 0.8ppt from our prior forecast and
well below the pace seen in 2010-2011, but still decent by historical standards. The main reason
is that we expect only a modest slowdown in China and other emerging economies. Although
the recent Chinese policy tightening and the downturn in export demand are likely to weigh on
growth in the next few quarters, we expect the waning inflationary pressures to lead to a
renewed easing of policy later this year, and this should underpin a moderate reacceleration in
2012.
The downgrade to our growth forecasts has led us to lower our targets for bond yields,
commodity prices and equity prices. While even the new targets are generally above the
forwards, the downside ‘skew’ to our market views has increased notably.
The Euro Crisis Intensifies
On account of the intensifying financial dislocations in Europe, we have substantially revised
down our outlook for economic activity in the Euro area over the next two years. The Euro area
economy entered the year strongly, with first-quarter growth of 0.8%qoq, or 3.1% at an annual
rate. A slowdown from this strength was expected, but the weakness in official and survey data
through mid-year has gone further than we expected. The new forecasts embody significant
downward revisions to Euro area growth for both 2011 and 2012. Our projections for year-onyear
growth rates in 2011 and 2012 are 1.7% and 0.1% respectively, with a recession—defined
as two successive quarters of negative growth—foreseen at the turn of the year.
On this basis, we expect inflation to moderate further in
the first half of 2012, giving the ECB ample room to
lower policy rates. We see the ECB lowering its repo rate
by 50bp in December, with the risk that a cut may come
earlier. With rates likely on hold in October, we think that
the ECB will focus its immediate attention on bolstering
its non-standard policy measures, aimed at supporting
bank funding and peripheral sovereign debt markets
where the current tensions are most acute. Given the
current market situation, there seems to be little prospect
of the ECB withdrawing significantly from these nonstandard
measures over the forecast horizon.
The rationale for our downward revisions varies across
countries. Alongside a recession in the short term and
stagnation next year, our new growth projections imply
additional intra-Euro area cross-country divergence. We
assume that financial dislocation in the periphery will
persist into 2012, compounding the effects of fiscal
consolidation on growth. We therefore project a more
persistent downturn in peripheral countries. The impact of
financial tension is less severe in most core countries,
with sovereign yields low and corporate balance sheets
strong. Nevertheless, the outlook for economic activity in
the core has also deteriorated, on account of the expected
weakness of demand from peripheral countries in
recession and, at least temporarily, by decisions to delay
investment in the face of elevated uncertainty stemming
from financial market developments.
Will the US Avoid Recession?
We have downgraded our US GDP forecast for 2012 to
1.4% from 2.0%, and now see growth bottoming at ½%
(annualised) in the first quarter of 2012. The reason for
our downgrade is the larger financial and economic shock
from the deterioration in the Euro area. We believe that
this could take around 1ppt off US growth over the next
year (although a small portion of this hit was already
included in our prior forecasts.) There are three main
channels of transmission:
A tightening of financial conditions as measured by
our GS financial conditions index, which we expect to
take about ½ percentage point off GDP growth over
the next year.
Decreased availability of credit, which could take up to
½ percentage point off GDP growth, although there is
not yet much evidence of a negative effect.
Real economy spillovers via reduced exports (both to
the Euro area and third countries), which might take
another 10bp off growth. (For more details, see
Andrew Tilton, “Will the European Storm Cross the
Atlantic?” US Economics Analyst, 11/37, 2011.)
The obvious risk is that this hit will accelerate the labour
market deterioration that is already underway, and will
thereby push the economy into recession via the ‘stall
speed’ effects that we have long noted. Indeed, our
forecast now calls for a (very gradual) increase in the
unemployment rate from a trough of 8.9% in early 2011
to 9.5% in late 2012. If this comes without an outright
recession, it would be the first time in postwar history that
the unemployment rate has risen more than 35 basis
points without an outright recession.
However, we believe that the expansion might be
somewhat less vulnerable to rising unemployment than it
has been in prior cycles. The main reason for this is that
the most cyclical sectors of the economy, such as
homebuilding, durable consumption, business investment
and inventories—which typically account for all of the
decline in overall real GDP in recessions—are already at
very low levels of activity and are unlikely to decline
dramatically further unless there is another very large
shock. (See Zach Pandl, “How Much Downside?” US
Economics Analyst, 11/39, September 30, 2011.) We
therefore believe that the risk of recession is ‘only’ 40%
despite the upward trend in the unemployment rate.
Moreover, if there is indeed a recession, we suspect it
would be relatively ‘mild’ for the same reason. (The term
‘mild’ is in quotation marks because it refers only to the
rate of change of activity and employment, recognising
that the levels are already unacceptably low.)
Whether or not the economy enters another recession, a
meaningfully above-trend recovery looks quite unlikely.
A key reason for this is that monetary and fiscal policy is
much less likely to make a positive contribution than in
past cycles. In fact, we expect fiscal policy at the federal,
state and local level to subtract about ¾ percentage point
from growth next year, even assuming that Congress
extends the 2011 payroll tax cut by another year and adds
a hiring tax credit for small firms. On the monetary policy
side, some additional easing is likely, and we expect a
return to quantitative easing—defined as the financing of
large-scale asset purchases by the creation of excess
reserves—in addition to the recent ‘operation twist’ either
later this year or in the first half of 2012. Moreover, the
recent discussion about potential changes in the
interpretation of the Fed’s dual mandate is likely to
continue. But, on balance, we do not expect a big positive
impulse from the policy side anytime soon.
Will China Keep Supporting Global Growth?
The stalling of economic activity in Europe and the US
has further increased the importance of continued
expansion in the emerging world—especially China—for
the global growth picture. It is admittedly easy to worry
about China’s resilience. For one thing, China is quite
vulnerable to slower growth in its major export markets -
as it is such an export-driven economy. We estimate that
a slowdown in world GDP growth (ex China) results in
about a 1-for-1 hit to Chinese growth, a much bigger
number than in any other major economy.
In addition, Chinese policymakers have tightened
aggressively in recent months, mainly via more stringent
loan guidance to the banks. The reason for this hawkish
policy stance is twofold. First, inflation has stayed higher
for longer than we expected. The main culprit is the surge
in food prices, which have risen 13.4% over the last year
and show only tentative signs of peaking in sequential
terms. Second, the sharp increase in overall leverage in
the Chinese economy—mostly in the local government
sector—has probably made Chinese authorities more
reluctant to respond to a deteriorating economic outlook
by easing policy as early as they did in 2011.
But while the external drag and the policy tightening are
likely to keep growth below trend in the near term, we do
expect a modest reacceleration in 2012. At the most basic
level, we do not believe that China is a ‘bubble economy’.
And while inflation has stayed higher for longer, we still
expect it to come down significantly in coming months,
with the headline CPI down to around 4% by November
from 6.2% in August. Combined with the slowdown in
global activity, this is likely to prompt Chinese
policymakers to ease policy anew, which should boost
growth with a relatively short lag.
Outside China, we have also cut our growth forecasts
across the bulk of the Asian and Latin American
economies and made further downward adjustments to
our EMEA forecasts.
A More Unfriendly Asset Market Environment
We have also adjusted our asset market forecasts,
although less dramatically. In particular, we now see:
Lower bond yields. Reflecting the shift in growth and
policy rates, we have lowered our bond yield profile
across the major markets. Those forecasts are now
around 75bp lower for German and US bond yields.
Given what are already quite stretched valuations,
however, we still find it hard to generate forecasts for
lower yields than current market prices without a
broader shift into recession across the major markets.
In EM, we are also forecasting more easing in Brazil
and shifting to forecast rate cuts in Mexico and Chile.
Lower equity index targets, with more pressure in
Europe in the near term. With the shifts in growth
views, our Portfolio Strategy teams’ earnings forecasts
have also come down, particularly in Europe where we
now forecast negative earnings growth in 2012, well
below the consensus. Our revised targets still look for
significant gains over 12 months in equity markets in
our central case, but with low conviction on the nearterm,
particularly in Europe (see Strategy Matters:
Risks deepen, stocks cheapen, also published today).
A bit less Dollar weakening. Our mid-September
issue of The Global FX Monthly Analyst already
acknowledged some of the forces that have driven this
latest round of economic revisions, and we cut our
EUR/$ forecasts there, alongside some EM currency
forecasts. We have made a further modest adjustment
now, and given weaker global growth are also taking
down our AUD and NZD profiles and forecasting a
weaker path for the BRL given a weaker balance of
payments outlook. But with a Fed still firmly in easing
mode, markets pricing more rate cuts than we expect in
most non-US markets, and a still-heavy US funding
requirement, we still controversially show Dollar
weakness persisting in the medium term.
A flatter upward trajectory for commodities, but
increasing risks to both the up and downside. The
weaker global growth path translates into weaker
global commodity demand but with our revisions
falling hardest on European growth and our EM
growth profile still relatively solid, our central
economic view is still one that generates enough
demand to continue to tighten the major commodity
markets. As a result, our Commodities team now sees
Brent crude prices ending this year at $112.5/bbl
(previously $119.50) and ending 2012 at $122.5/bbl
(previously $138.50), while we are pushing out the
timing of a tight copper market and lower our 12-
month price forecast from $11,000/mt to $9,500/mt.
While we recognise the downside risk to our forecast
from a potential European financial crisis, we also
believe it is important to recognise that an event so
widely anticipated will likely have an impact if it does
not occur. The oil market continues to destock as
prices anticipate a potential crisis. If the crisis does not
occur, the oil market risks running into pressing supply
constraints, requiring sharply higher prices than we
currently forecast to force demand in line with
supplies.
The question is why we are not shifting these forecasts
more. Even after revisions, they still leave us—in our
central case at least—bearish on the Dollar, bearish on
rates and bullish on commodities and equities.
The answer is that our central forecast path is still one
that looks more benign on average than the market is
pricing. We have argued for some time that US rates
markets and cyclical equities are pricing something close
to a mild recession already; our view of the ECB, while
now incorporating rate cuts, is still more hawkish than the
forwards, reflecting our belief that the ECB still has a bias
towards unconventional over conventional tools to deal
with the periphery’s economic crisis; and without a
sharper demand slowdown in China/EM than in our
central case, we see commodity supply tightness still
becoming a binding constraint.
But the market outlook continues to be complicated by
the fact that many markets are priced for a scenario that is
significantly worse than our central case—albeit still
arguably better than a full global recession. In that sense,
clichéd though it now is, the world remains essentially
somewhat ‘bimodal’. Until we can be confident that the
markets will be able to choose decisively in favour of one
of these, we are likely to see a continuation of the high
volatility that we have seen lately.
Because of that, as at other times of deteriorating
economic momentum, we think it is dangerous to lean too
heavily on point forecasts of asset markets. In this more
fluid environment, we have emphasised instead the
conditions for markets to manage a sustained
improvement of the kind consistent with our central
forecasts. In particular, we have emphasised that three
sources of pressure—deteriorating data, tightening
financial conditions and intensifying banking stresses—
will likely need to reverse before markets can sustain an
improvement. Until we see those conditions—and as yet
we have not—we think it makes sense to take a cautious
view of asset markets. Stability of some kind in these
areas is certainly consistent with our revised economic
forecasts, but in practice the point at which we may see it
is hard to determine with much precision.
We are also watching carefully for any cracks in one of
the most critical assumptions in our current outlook: the
notion that financial transmission to the EM world will be
limited. If economic pressures broaden, it is that
assumption—and with it the outlook for commodities,
and to some degree the Dollar—that will be most
vulnerable. But if our central forecasts are closer to
reality, then markets could relax significantly at the point
where it becomes clearer that the threats are receding. We
still see it likely that policy will play a major role in
determining which of these outcomes dominates. A more
rapid shift towards conventional policy easing in Europe,
China and beyond and a quicker shift towards a
comprehensive recapitalisation plan for Euro area banks
would all be helpful on that front.
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