Review of 2009: Back from the brink
Tue, Jan 12 2010, 12:17 GMT
by Lloyds TSB Financial Markets Economic Research Team
2009 is likely to go down in the annals of history as the year in which policy makers successfully averted a global economic catastrophe. It now seems difficult to believe that it was just over a year ago that the world economy was looking into the abyss. The contagion resulting from the earlier collapse of Lehman Brothers was casting a dark cloud, equities were hitting new multi-year lows and a tightening in global liquidity was threatening to send what was already a global downturn into a depression.
Yet twelve months on, the outlook has improved markedly. Courtesy of the aggressive actions of the major governments and central banks, and the resilience of some of the emerging economies, an ongoing downward spiral in global economic activity has been prevented. As we enter 2010, global GDP is again expanding, the major equity markets have posted impressive bounce-backs, and the provision of global credit, while still hampered, has undoubtedly improved.
Consensus proves too optimistic... Given the turnaround, it is perhaps surprising that the official outturns for growth for last year generally proved far weaker than the consensus estimates taken at the end of 2008 (see chart a). What almost all economists clearly (and perhaps not surprisingly) missed was the magnitude of the unprecedented downturn in the first three months of 2009. In the first quarter alone, the level of GDP dropped by 3.5% in Germany, 3.0% in Japan, 2.5% in the UK and by 1.6% in the US. The quarterly falls effectively wiped out the equivalent of a whole year of trend growth, if not more, for most of these economies.
...but conditions have improved Since the second quarter, however, conditions have clearly improved. The decision of the major central banks to embrace unconventional policy measures – such as quantitative easing - from the end of March marked a major turning point. While consensus GDP forecasts were revised sharly lower in response to weaker economic data in the early part of last year, they subsequently bottomed out as the stimulus measures began to take effect. Japan, Germany and France all returned to positive growth in Q2, and the US and euro zone in Q3. The laggard was the UK, where growth forecasts were revised steadily lower for most of last year. Over the past quarter, however, it too appears to have emerged from recession.
While the turnaround in the fortunes of the global economy has been impressive, the performance of global asset markets, particularly equity markets, has been even more striking. The improvement in economic confidence and the flood of global liquidity unleashed by the unconventional monetary policy measures precipitated a marked turnaround in global equities. By the end of 2009, the US S&P500 had risen by 23%, the FTSE Eurofirst 300 by 26% and the UK FTSE 100 index by 21%. From their early March lows, the gains were closer to 60-70%.
Inflation drops sharply As with the GDP forecasts, the consensus expectation for CPI inflation for most of the major economies in 2009 also proved far too high (chart b). Last year saw the US and euro zone experiencing record price falls and Japan re entering deflation. A notable exception was the UK., where the headline rate of UK CPI bottomed at a five-year low of 1.1% in September. However, the annual RPI, which captures house price depreciation, fell to a record low of -1.6%. As we move through 2010, economists’ opinions over the global inflation outlook differ between those that believe that spare capacity and weak growth will keep inflation pressures at bay, and those that think rising commodity prices, economic recovery and the flood of global liquidity will unleash a global inflation shock.
10-yr government yields rise, as expected Although both GDP growth and inflation proved weaker than expected in 2009, the consensus estimates for 10-yr government bond yields proved remarkably accurate (chart c). Over the year, 10-yr government yields were pushed higher by signs of economic recovery and rising government bond issuance to finance increasing fiscal deficits. In the UK, 10-yr gilt yields ended the year around 100bp higher at 4.0%. The rise occurred despite the £175bn+ of gilt purchases by the Bank of England as part of its Quantitative Easing programme. The fact that gilt yields still rose highlights the vulnerability of the gilt market (and other government bond markets) once policy makers start to reverse the policy stimulus.
Fall in the US$ imparts additional stimulus In the currency markets, 2009 saw a renewed weakening of the US dollar versus the majors – except against the yen, where a late US dollar rally pushed the currency pair back above its value at the start of the year (chart d). The fall in the US dollar imparted additional stimulus to the US and those countries with dollar-linked currencies by boosting their competitiveness. In line with other asset markets, currency volatility dropped back from its earlier peaks – a further reflection of the improvement in risk appetite. More generally, sterling was a noticeable underperformer over the second half of the year. Sterling weakness was a key theme for the UK in 2009 and is likely to remain so over the coming years, as the UK seeks to rebalance its economy away from domestic demand towards net exports.
A sigh of relief that it wasn’t a lot worse In sum, last year was an exceptionally weak year for the world economy, with the full-year outturns for GDP growth dropping to multi-decade lows. That said, most can breathe a sigh of relief that it was not much worse. Courtesy of the aggressive actions of policy makers, financial market confidence and, to a lesser extent, economic confidence have bounced back. While policy makers can be applauded for their swift and coordinated response, it is too early to be confident that we are out of the woods. It remains to be seen whether policy makers can manage an orderly withdrawal of the unprecedented stimulus without tipping the world back into recession or unleashing an inflation shock. This, perhaps, is the single biggest uncertainty facing the global economic outlook as we head through 2010.
