World growth still on track
Tue, Jul 27 2010, 05:03 GMT
by Trevor Williams
Fears are growing that the global economic recovery is already running out of steam. A plethora of economic data in a number of countries over the last month or so have shown that economic growth is slowing. In the US, the housing market is under renewed downward pressure as official support is gradually withdrawn. At the same time, US employment growth remains sluggish. In Europe, the problems of Greece, Portugal, Italy and Spain dominate the agenda as high levels of government debt have led to a crisis of confidence in financial markets about sovereign risk. Even in the fast growing emerging market economies, survey data suggest that the pace of growth is easing. But this is not in fact unusual: no recovery occurs in a straight line, and this one is no exception. This means that setbacks during the recovery phase should be expected and are not a reason for doubting it and expecting a double-dip.
We look at some of these issues in this Weekly, concluding that despite the setbacks global growth remains on track for a 4% plus rate this year. However, growth will likely settle at a lower pace in the second half of 2010 than recorded in the first half. Unfortunately, this leaves a risk that financial markets overreact to signs of renewed economic weakness, with bond yields falling further and equity markets pricing lower company earnings growth. Our forecast for world growth suggests that this would be a mistake, as global growth is set to be around 4.5% both this year and next. Massive fiscal easing, sharp cuts in interest rates, a reopening of trade supply routes, shut down temporarily by fears about trade finance, and injections of liquidity by central banks are doing their job and boosting recovery. But these effects behave like a wave, and after an initial burst, growth will slow before resuming again. This does not mean that recovery has ended; more like a pause for breath before a resumption.
However, it is clear that Purchasing Managers’ Indices (PMIs) in the last two months have taken a bit of a tumble, see chart a. The correction is almost uniform, with the sharpest declines in the US, UK, euro zone and China, where the drop has been sharpest. Supporting evidence of the fall can be found in data for housing markets in the US and China, and in consumer and retail spending trends in the euro zone. In the UK, PMIs have also headed lower, with signs that housing activity is weakening. However, preliminary Q2 UK gdp data highlight that the recovery remains on track in spite of the evidence from the PMIs, with a rise of 1.1% in Q2, to a 1.6% annual rate, the first positive annual rate since Q2 2008. Admittedly, we have serious doubts about the sustainability of the pace of recovery implied by the Q2 data, as high frequency data for July and Q3 are hinting at a significant cooling.
A closer look at the PMI data for the US, euro area, China and the UK show that what they are showing is a deceleration in the pace of growth. Hence our belief is that what we are witnessing after a few quarters of rapid economic activity in many economies is a slowing in the rate of growth and not an outright decline. Aside from Spain, all of the advanced economies in the G10 are expected to grow this year and next. Still, differences do exist between the advanced economies and the developing economies, as the latter grow rapidly. One of the reasons for the growth disparity is that the advanced economies are encumbered by the after-effects of the worst financial crisis to hit them since the Great Depression, on the balance sheets of households, companies and governments. It would be naïve however to believe that this was the sole reason for the growth disparity as this was evident well before the financial crisis, when growth rates in the emerging countries were two to three times faster. More scope for catch-up, vast supplies of cheap labour and strong productivity allied with better governance and more open global markets, are all behind the faster growth of the emerging market economies.
The latter are expected to grow by 7.4% this year and the developed economies by 2.3%, and this difference persists next year as well. It is also striking that the pace of global growth is expected to almost remain the same next year, despite weak price inflation. Our forecast shows that global price inflation not only remains low but falls further in 2011. What causes this is a tighter policy stance in the emerging economies. This should be seen as good news, as it makes growth more sustainable in these economies over the longer run.
Nevertheless, it is too soon to sound the all-clear for global growth, as issues around sovereign default risk in Europe, fiscal austerity plans and high levels of unemployment could keep private sector spending weak and limit the recovery. However, doubts about the recovery are keeping bond yields low, which in time will help foster recovery. In addition, the lack of a more robust recovery in the advanced economies is acting to keep down global commodity price inflation. This is acting in turn to limit the need for the emerging market economies to tighten policy even more aggressively, as inflation is lower than otherwise. The upshot is that global growth is still on track for a ‘v’ shaped recovery, but expect a weaker second half in 2010.
