Another year of below-trend global growth
Our view is that the global economic outlook for 2013 is best defined as weak, with the chance of becoming bleak. Our core view points to global economic growth of 3.0% in 2013, down from 3.1% this year and below the trend rate of global growth of around 3.75%. Once again, the developed markets comprise the most notable source of weakness, expected to expand by just 0.7% next year, down from an already soft estimated 1.2% in 2012.
Reasons for weakness
1) Echoes of a burst bubble
One reason for the continued weak performance of developed markets is the lingering repercussions of the bursting of the credit bubble five years ago. Household, corporate and financial sector balance sheet restructuring remains a theme across many countries, which is limiting leverage in the system and rendering consumption growth more a function of income growth. The post-crisis push for deeper financial sector regulation is adding a further headwind to global growth. To illustrate using the Basel 3 regulatory framework, this increases banks‟ capital charges and forces them to rely on longer-term, more expensive funding. As such, banks are growing more discerning over their use of their balance sheets, resulting in spreads between lending rates and the policy rate structurally widening.
2) The ongoing eurozone crisis
A second key reason for the weakness in global growth is the continuing eurozone crisis. Policy settings in the eurozone are deeply restrictive, with governments implementing a policy of pro-cyclical fiscal tightening. Moreover, peripheral countries face a zero-bound problem, which is made worse by weakness in domestic banking systems resulting in a break in the transmission mechanism from low policy rates to broader lending rates. In short, Europe is in an unstable equilibrium, with a deepening growth crisis belying the European Central Bank's (ECB) efforts to address the financial crisis. We expect eurozone GDP to fall by 0.8% next year following a decline of 0.5% in 2012. Europe's current policy settings seem incompatible with a notable economic recovery over a meaningful timeframe, and in peripheral markets the outlook is for depression rather than recession. In Spain, we expect GDP to fall by 3.0% next year and by 1.5% in 2014, while we forecast Greek growth of -4.2% for 2013, which would be a sixth consecutive year of recession. (The question of official sector involvement in Greek debt relief, and indeed the stability of the country‟s presence in the euro, should remain sources of uncertainty in 2013.) Europe is set to remain a heavy weight on global growth over the medium term. Needless to say, Europe's inability to grow means that solvency concerns will remain elevated in the peripheral economies in 2013, and we see a risk that these concerns creep into some semi-core markets, such as France. 3) Pro-cyclical fiscal austerity A third constraint on growth is the extent to which fiscal policy restrains demand. In the US, even if the fiscal cliff is smoothly traversed, our US research team notes that current policies will see fiscal policy reduce growth by 1 percentage point (pp) next year (if we go over the fiscal cliff permanently, then clearly a deep, double-dip recession looms). We have already noted the pro-cyclical fiscal policy in the eurozone that is helping to push many countries into unstable equilibriums, while we do not expect the UK government to blink in the face of anaemic growth, and we assume it will continue efforts to rein-in the budget deficit. However, one developed country that might buck the trend of fiscal restraint is Japan. Post-earthquake reconstruction spending should remain a continued support to economic growth, but one possible additional spur to consumer demand is the anticipated consumption tax hikes in 2014 and 2015. As was seen before Japan's last consumption tax hike on 1 April 1997, this has the potential to see consumers bring forward their spending plans. Of course, the experience of 1997 is not a happy one for Japan. The consumption tax hike saw growth slide over the
subsequent 12 months, primarily due to the deterioration in financial stability and the Asian economic crisis. However, we are confident that history will not repeat and our economic research team is comfortable in assuming that positive growth can be maintained in 2014 after a tax hike in April is implemented. Few monetary policy shibboleths will remain One of the additional themes of 2013 is likely to be the degree to which central banks will try to offset weak growth by adopting yet more unorthodox monetary policies. In this respect, the ECB and the Bank of Japan (BOJ) are likely to be at the forefront of embracing fresh unorthodoxy. In the eurozone, we expect a renewed escalation in the crisis as the proposed firewall proves inadequate to address the lingering solvency concerns in non-core markets. This should once again force the ECB into the unwanted position of having to contemplate even bolder and previously unpalatable monetary responses, or be confronted with a realistic prospect of a euro break-up. However, in Japan a potentially greater and more structural change may be taking place in monetary policy. The growing political influence over the BOJ is expected to be reinforced by the appointment of BOJ Governor Shirakawa‟s replacement next April. Q2 1013 should also be a critical time for Japan as the government will be making the final decision on whether it implements the April 2014 consumption tax. We expect the increased political pressure on the BOJ to embed a trend towards bolder monetary policy easing given that inflation is expected to undershoot the goal of 1%. We expect a weak JPY to be a feature of 2013. The extent of monetary policy gyrations taking place in Europe and Japan are so notable that, in comparison, the continued aggressive and bold monetary policy trends in the US and the UK appear rather routine. In the US, we assume that the Fed will maintain its USD40bn a month rate of MBS purchases until Q3 2013, while Operation Twist will be replaced with a programme of outright Treasury purchases. Meanwhile, in the UK – where the Bank of England (BOE) has expanded its balance sheet proportionally more than all other G10 central banks since the onset of the crisis – we expect the BoE to deliver just a GBP50bn expansion of QE3 in February, taking the asset purchasing fund to GBP425bn. Our UK economics team does not expect a trend of above-target inflation in 2013 to restrain the BOE from its focus on supporting growth. In the emerging world: Brazil to outperform the other BRICs We expect that once again, emerging markets will provide a partial – but not compete – offset to weakness in developed markets. Although even here, our optimism is equivocal. Of the crucial BRIC economies, we expect Brazil to display the most improved growth outlook in 2013 as the economy rebounds on the monetary and fiscal stimulus delivered this year. We forecast Brazilian growth to rebound to 4.1% in 2013 from an estimated 1.3% this year. One interesting theme in Brazil next year will be how long the central bank will refrain from tightening monetary policy in the face of recovering growth and an expected uptrend in inflation following a cumulative 525bp of cuts to the Selic rate since August 2011. Within Asia, our out-of-consensus forecast for a policy-driven rebound in growth in China in Q4 2012 and Q1 2013 is being validated by an upswing in economic data. However, we also assume that China's unleashed policy stimulus will be short-lived, as inflation rises in 2013. The current investment-led stimulus and rapid expansion of financing outside the regulated banking sector could also exacerbate the already large structural problems in the economy. Therefore, we expect GDP growth to slow back towards 7.0-7.5% levels from H1 2013 onwards. Full-year 2013 growth is forecast to be lower than in 2012. We also maintain our one-in-three probability of a hard landing (i.e. GDP growth averaging 5% or less over four consecutive quarters), starting to play out before the end of 2014. Meanwhile, we expect a very shallow recovery in the other Asian BRIC – India – where growth remains weighed down by a lack of structural reforms (we are sceptical that recent reform announcements will be fully implemented ahead of elections in 2014) and by the related trend of “sticky” inflation. Elsewhere in the EM world, we expect the EEMEA region to be split between stronger growth outperformers like Turkey and Poland, and those suffering from a mix of domestic idiosyncratic risks while feeling greater pain inflicted on them by the eurozone crisis. This group includes Hungary, South Africa and the Balkans, where narrow funding tightropes will need to be walked.
Pockets of optimism and upside risks to the core view…
Nonetheless, there are some clear pockets of optimism within our generally downbeat global economic outlook.
As the uncertainty surrounding the US fiscal cliff dissipates, we anticipate a capex-driven rise in US growth in H2 2013 (helped by an ongoing housing market recovery), such that we expect the US to post above-trend rates of expansion into Q4 2013. This underpins our view that the Fed will call time on its latest round of QE in Q3 next year as the outlook for unemployment should have improved.
In Europe, one possible upside surprise is if policymakers start to target structural reforms and structural budget deficits more than nominal budget deficits. While this might not remove the pro-cyclical fiscal tightening already in motion, it may be able to break the cycle of weak growth undermining deficit-reduction targets, leading to fresh austerity, leading to weaker growth…
In the developed world, inflation is expected to be contained, which should allow monetary policy to focus more directly on growth considerations.
… but there remains an asymmetry around the risk
However, when looking at the world economy it is clear that an asymmetry exists as the downside risks are profound.
In Europe, our forecast for a deep regional recession and depression in some countries already assumes further bold monetary policy responses. What if Spain and Italy require a full bail-out and the Troika is unable to provide sufficient funding? As our European economics team says with regard to the eurozone: “The currency might be irrevocable but membership is no longer”.
In the US, the fiscal cliff looms large as a downside risk. Although, on this point we assume that the severe economic consequences of going over the cliff will provide something of a self-equilibrating mechanism to the political machinations: we assume that economic weakness would swiftly force politicians back to the negotiating table. Our US economists outline how a temporary leap off the cliff would have a far less damaging impact on growth than a persistent shock. In essence, a fiscal bungee jump versus a fiscal swan dive.
In China, the perennial risk is that the country fails to engineer a soft landing. After all, this would be an historic achievement since there are no precedents of a large country experiencing a controlled descent from such a rapid expansion of credit and investment growth.
In Asia generally, our team notes that trend growth rates are declining. In this context, the decline in the region‟s current account surplus is somewhat worrisome since it is happening for the wrong reasons.
Given how bleak the sum of these risks is, our weak macroeconomic baseline scenario might not be such a bad outcome.
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