A year of falling global output lies ahead
Tue, Jan 13 2009, 07:18 GMT
by Lloyds TSB Financial Markets Economic Research Team
This year promises to be the worst for the UK economy since the 1980s. For the world economy, the downturn is set to be the worst since 1945, partly because the advanced economies as a group are entering recession en masse. And although growth in the emerging markets as a group will likely remain positive this year, global economic growth, measured in terms of market-price exchange rates, is now likely to be negative (see chart a). In terms of growth adjusted for price differences between countries, which gives more weight to the emerging markets, global growth could be positive, but still the weakest since the 1970s. With price inflation down markedly as commodity prices drop back and spending growth weakens, interest rates are being cut to record lows in most major economies. But the ongoing credit crisis means that global financial markets remain under severe strain, even though there have been some signs of stabilisation in recent months.
Economic data have turned decidedly for the worse in recent weeks…
Economic news has taken a sharp turn for the worse in the last few weeks, with growth forecasts having to be revised lower around the world. In the UK, the figures for economic activity have been equally poor. In particular, see chart b, the manufacturing sector has been seeing falls in output at odds with what might have been expected given a relatively good financial position and low stock levels for this stage of an economic downturn. However, the pressure on the UK corporate sector appears to be intense, with chart c showing that holdings of M4 bank deposits by companies fell by 6.2% in the year to November. Unfortunately, this is entirely consistent with falling output and declining profits in the context of sliding demand and constrained credit availability. The implication is that layoffs will also rise strongly in the months ahead, something that company surveys are suggesting; leading perhaps to a sharper fall in volume retail sales, see chart b, than seen so far. With this poor backdrop, the Bank of England has cut Bank Rate to a 315 year low of 1.5% in January, and further cuts to 1% or below in the months ahead seems currently more likely than not.
…and although weak price inflation is allowing record cuts in interest rates, a sharp global recession is now unavoidable despite substantial policy loosening
Price inflation is not a barrier to UK interest rate cuts, with earnings growth slowing and annual consumer and retail price inflation likely to turn negative for some months later in 2009, see chart d. In other words, for the next few years, interest rates are likely to stay low as price inflation will stay low. Of course, the fall in the pound’s exchange rate does imply some rise in UK imported price inflation pressure, and commodity prices are out of the control of the Bank of England, but weak growth in overseas markets and consequent weaker demand for commodities is likely to keep global inflation pressure subdued for the next few years.
However, there is little that either cuts in interest rates or fiscal easing can do to prevent economic growth in Q4 2008 from falling by possibly 1.5% with a 1% decline possible in Q1 this year. This means that the current UK economic downturn will be on par with the average of the last three recessions – annual gdp will fall for about six quarters, see chart e. On our forecasts, annual UK gdp growth does not turn clearly positive until Q2 2010, with quarterly gdp falling in every quarter until the fourth quarter of this year. Chart g shows a projected range for the likeliest path that gdp will take this year and next.
...and sustained recovery is now unlikely before 2010
On the basis of the monetary and fiscal easing currently in place, and further easing likely to be adopted in the months ahead, the eventual economic recovery could be strong when it takes place, but above trend growth is now unlikely until 2011, with the recovery gathering pace in the second half of next year. However, the UK has had 16 years of uninterrupted growth and this has led to imbalances, in balance sheets and in the trade and current account deficits that were simply unsustainable. Some correction was unavoidable. However, the bursting of the credit market bubble is exacerbating the downward leg of the economic cycle, just as its inflating may have pushed the cycle upward, and this will likely lead the Bank of England to adopt unconventional, or little used methods since the 1970s, to tackle the economic slowdown and the credit crisis. Chances are that there will be efforts to guarantee bank loans and tackle the credit crisis by taking the ‘toxic’ securities off banks balance sheets by creating a ‘bad bank’ to hold them. Whatever happens, the year ahead will prove to be one of the most challenging on record after one of the most volatile ever seen.
