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Economic and Financial Outlook 2008

Wed, Jan 9 2008, 11:23 GMT
by Allan von Mehren

Danske Bank A/S

A new year has started and a fresh new page has been opened. Below we give a summary of our macro-economic and financial views for 2008.

Macro and central bank outlook:

• Global macro: The global growth cycle has peaked. So far, the slowdown has been led by the US and the UK, which have been mostly exposed to the credit crisis. During the year the weakness will spread to Europe and to some extent emerging markets. However, we still expect emerging markets to out-perform relative to developed economies. Consequently, the global central banks will begin to ease monetary policy, as rising concerns on growth will outweigh the inflationary risks from tight global commodity and labour markets.

• US: The economy faces a tough ride in H1 as the financial crisis, rising energy prices and a continua-tion of the housing correction take a heavy toll on the economy. Although it is not our main case, re-cent data have highlighted the risks for a recession. Indeed, with growth forecasted to average only 0.75% AR during H1, the economy will be flirting with a recession early in the year. This leaves down-side risks to growth as the predominant concern for the Fed, which we expect to cut interest rates by 25bp at each meeting during H1. This would take the Fed funds rate to 3.25% at the June meeting. In H2 the economy is expected to stabilise slightly below trend growth, as most of the current negative factors will ease off and monetary accommodation will gradually begin to take effect. The risk to our forecast is that the slowdown could prolong and become self-perpetuating, with the Fed easing more aggressively.

• Euroland: Exports are set to lose momentum during 2008 as Eastern Europe and Russia are facing a slowdown, and as other traditional trading partners also continue to slow. Furthermore, consumers face substantial headwinds from falling real wages. Finally, investments will suffer from the slowing of exports and consumer demand as well as from the tightening of financing conditions. The risks of a hard landing have thus increased, and we now expect pressure to mount on the ECB to cut rates in September and December this year to take into account this risk. Uncertainty is larger than normal, and the ECB may prefer to remain sidelined if global growth does not ease much, and if underlying la-bour market dynamics are not hurt much. Also, should second-round effects materialise through strongly rising wage growth, this will definitely prevent the ECB from easing rates. In our view, the chances of the next rate move being a rate cut rather than a rate hike are 75/25.

• Japan: Growth probably slowed markedly in Q4 on both weaker residential investment and private consumption. However, exports continue to perform strongly and industrial production has main-tained momentum into 2008. Growth is expected to pick up in early 2008 due to a strong recovery in housing construction and stronger private consumption. Export growth will slow slightly during 2008 and the main risk to the Japanese economy is that export growth could slow more than expected dur-ing H2 08. Overall monetary conditions in Japan remain accommodative. The timing of the next inter-est hike will mainly be dependent on some signs of stabilisation in global growth. The Bank of Japan is expected to hike its leading O/N target rate by 25 bp to 0.75% in late Q4 08. Hence, the next rate hike in Japan has been postponed slightly from October/September.

• Emerging market: Overall growth in emerging markets will slow slightly on both weaker export growth and domestic monetary tightening. Hence, while we expect the emerging markets to outperform thedeveloped markets on growth, we do not expect the emerging markets to provide additional momen-tum to the global economy in 2008. In the emerging markets particularly Asia is expected to do well. However, Central and Eastern European growth is expected to slow fairly dramatically during 2008. Most at risk are the CEE countries with the largest imbalances – the Baltic states, Romania and Bulgaria.

• Scandi macro: The macro story in Sweden and Norway will remain one of two very different economic outlooks. The Swedish economy is very exposed to the international economic downturn given its large dependence on exports and we will see a rather severe decline in Swedish growth in 2008. Infla-tion in Sweden is likely to undershoot the expectations of both market BEI rates and many analysts. The slowdown in growth is expected to pave the way for two rate cuts from the Riksbank in the second half of 2008. The international downturn will not pass unnoticed in Norway, but the Norwegian econ-omy is far more shielded from a drop in international demand than Sweden or Euroland due to its ex-posure to oil. Moreover, the Norwegian economy is still in a state of overheating and we are facing real wage-driven inflation risks going forward. However, there are signs of weakness in the housing mar-ket. We may still see another rate hike from Norges Bank in Q2 to fight the overheating tendencies in the economy.

The Danish economy is expected to shift down a gear this year. We project GDP growth around 1.5% in 2008 and slightly less next year. The labour market is still at risk of overheating and thus a soften-ing of domestic demand is welcome. House prices are expected to fall slightly in 2008 and this will dampen construction and private consumption, although consumption is supported by tax reductions in both 2008 and 2009. Exports are projected to grow modestly – constrained by higher than abroad wage growth and recent increases in the effective exchange rate. A referendum on the four EU opt-outs is expected late 2008 or early next year. However, it is not certain that a referendum on euro participation will be included. In the event of a euro referendum, the odds are that the Danes will vote in favour of participation, but as always it will be a close race. Participation will result in a narrowing of interest rate spreads.

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Published on  Wed, Jan 9 2008, 11:35 GMT

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