Friday, June 19, 2009
Global Forecast Update: After the Deepest Recession, the Weakest Recovery
By Joachim Fels London Bottom-fishing: In our previous Global Forecast Snapshots two months ago, we argued that a bottom for the global economy was in sight. Our global team's read of the data released since then suggests that the bottom now seems to be in place and has thus arrived a bit earlier than expected. Following three quarters of outright contraction - during which global GDP dropped by about 3% from its peak in 2Q08 to the (likely) trough in 1Q09 - we estimate that the global economy returned to positive, though very subdued, growth in the current quarter. While we had still expected global economic activity to contract slightly in 2Q09 two months ago, we currently see global GDP tracking at a positive 2% seasonally adjusted annualised pace this quarter. Thus, the massive global policy stimulus applied in response to the credit crisis has successfully short-circuited the vertiginous downward spiral of global demand, output and trade witnessed during late 2008 and early 2009. As we see it, the stimulus helped to spark the recovery in risky asset markets and vaporised deflation fears, thus supporting economic activity. Asia leads, the US and Europe lag: Remarkably, global GDP growth has turned positive even though the US and euro area economies, which together account for more than 40% of global GDP, are still sinking. We only expect these two laggards to start growing gradually later this year. The turnaround in global activity almost entirely reflects a bounce in Asia in recent months, led by China and now becoming visible too in Japan, India and elsewhere in the region. Consequently, our local teams in Asia have upgraded their 2009/10 GDP forecasts for most countries over the past two months. With commodity prices having risen on the back the rebound in Asia and ample global liquidity, our Latin American economists have also just revised up their forecasts significantly, especially for Brazil (see This Week in Latin America, June 16, 2009). By contrast, our 2009 euro area GDP forecast has been downgraded again, reflecting the even-worse-than-expected outcome for 1Q and a bad start to 2Q. Likewise, most of our recent revisions for 2009 GDP in Central and Eastern Europe have still been on the downside. After the deepest recession, the weakest recovery: While global bottoming is now happening, we continue to believe that hopes for a V-shaped global recovery will be disappointed. Consumers are likely to be cautious in the face of rising unemployment (labour markets lag), companies will hold back on capex in the face of high excess capacities, and construction activity is unlikely to rebound sharply with house prices still falling in many countries. Thus, final demand growth is likely to be sluggish in the foreseeable future, despite the strong support from fiscal and monetary policies. In our baseline forecast, we see global GDP expanding at quarterly annualised rates of only 2-3% between now and the end of 2010, unusually low for early recovery phases. This would take full-year 2010 GDP growth to 2.9% (from -1.6% this year), still well below the 4.7% average annual growth rate in the five years preceding the crisis. Given the downdraft in activity over the last few quarters, our forecasts imply that it would take until the middle of 2010 for global GDP to return to its previous peak level reached in 2Q08. In the G-10 advanced economies, which were hit harder than most EM economies by the credit crisis and which we expect to show a very anaemic recovery, only about half of the total GDP peak-to-trough loss of some 4.5% during the recession will have been recouped by the end of 2010. Could we be wrong? Yes, easily, because of the unprecedented combination of a hugely negative shock to the financial system, whose effects are still lingering, and a massive monetary and fiscal response. All available models are estimated using data on ‘normal' business cycles and policy reactions, and are thus of little help in gauging what lies ahead. That's why we continue to emphasise the risks on both sides of our base case and regularly construct a bull and a bear case that should each have a ‘reasonable' outside chance (of about 20% each) of occurring. In our bear case, we assume that policy finds very little further traction in the advanced economies in the remainder of this year, risky assets tumble again and EM recoveries falter as global risk-aversion returns. Global GDP would shrink by 3% this year (against -1.6% in our base case) and grow by only 1.4% next year (base case: 2.9%). Conversely, in the bull case, policy finds strong traction, asset markets rally further and the financial sector recovers quickly, translating into a V-shaped recovery that produces close to 5% GDP growth in 2010. No early monetary policy reversal: With the economic recovery likely to be tepid, the financial sector remaining fragile and inflation expected to remain subdued, we expect the major central banks to keep rates at the currently abnormally low levels for the remainder of this year and, in most cases, well into next year. On our baseline forecasts, the Bank of England and the Bank of Canada will be first out of the blocks, probably in 1Q10, followed by the ECB and the Swedish Riksbank in 2Q. Our US team has pencilled in the first Fed rate hike for around the middle of next year, and our Japan team sees the Bank of Japan starting to tighten only towards the end of 2010. As we have argued elsewhere (see "QExit", The Global Monetary Analyst, May 20, 2009), most central banks are likely to unwind quantitative easing very gradually and with simultaneous increases in official rates. With much of the announced quantitative easing still to come over the next several months, and policy rates likely to remain at their very low levels until 2010, we believe that global excess liquidity is likely to rise further and remain plentiful for the foreseeable future. For our complete forecasts, please see Global Forecast Snapshots, June 18, 2009.