Shift in economic regime in the US

The steepening slide in the oil price is giving consumer spending a boost in advanced economies, but heightening risks facing emerging nations. As a result, the world economy is getting even further out of sync.

The global economy is becoming increasingly desynchronised. A shift in macroeconomic regime has materialised in the US, with the business and economic cycle taking over as driver from monetary policy. In Europe, pressure is mounting on the European Central Bank (ECB) to unfurl a programme of quantitative easing (QE) at a time when tumbling oil prices are providing a further factor driving down consumer price indices.

Slump in oil price generating new dynamics

With 2015 less than a month away, a shift in regime is shaping the fate of the world economy. The US is in the vanguard as the regime of its economic and business cycle is becoming firmly installed, taking over from the monetary-policy driver in late October as the Federal Reserve wound up its QE3 programme. The world’s economic powerhouse should help to lessen the potency of adverse forces at work in the other main economic blocs. The economic landscape world- wide remains very much out of kilter though as the spectre of deflation menacingly stalks Europe and economies are decelerating in much of the emerging world.

Some emerging economies – those heavily reliant on oil output and the price of a barrel – are being plunged into a potentially critical predicament as the price of oil plummets faster and more steeply, sinking from USD80 in early November to almost USD70 barely a month later. Russia has been hard hit: the rouble has been sinking like a stone, pressure has been exerted on credit default swaps involving Russian debt and the economy is predicted to slump into recession in 2015. In Brazil, Petrobras has already announced its debt will climb and that it would have to postpone investments in oil-drilling projects. The repercussions of cheaper oil on these economies run the risk of triggering a domino effect through the global economy.
As for the developed world, plunging oil prices, so far, have been seen as welcome. Consumers’ purchasing power is increasing, in turn giving economies a handsome boost. On the downside though, falling oil prices exert extra pres- sure on consumer price indices in Europe. Eurozone mon- etary policy at present has potentially been nudged even further out of phase with the ECB’s price-stability targets for inflation. Quantitative-easing measures may well have to be pushed through by the ECB as early as the outset of 2015.

US: GDP growth in 2015 likely to be its fastest for 10 years

Once the preliminary estimate was revised, GDP growth in the US worked out at an annualised q-o-q rate of 3.9% in Q3 2014. As defence spending created some distortions in the statistics and temporarily bloated GDP, the rate is likely to ease back to around 2.5% in Q4. Looking ahead to 2015, we remain confident about prospects overall. The negative impact from the firming dollar should be offset by the beneficial effects of the recent slide in the oil price (see our ‘Topic of the Month’ article on pages 12-14 for a more in-depth analysis). We are projecting GDP growth for the US economy should average 3.0% in 2015, its strongest rate of annual expansion since 2005.

The Fed patently finds itself increasingly uncomfortable on the horns of a monetary-policy dilemma. On the one hand, the unemployment rate is falling quickly and the US economy is fast approaching its full-employment state even judging by broader measures of unemployment. Against that backdrop, keeping short-term interest rates close to zero for much longer might seem to be running a risk. On the other hand, inflation remains mild and wages growth pedestrian. Furthermore, risks look asymmetrical. The consequences of moving too early to tighten monetary policy would probably end up being distinctly more harmful than taking action a little too late. Disparities between these two assessments are discernible in the sizeable gap between interest-rate projections arrived at by different Fed Board members. At the bottom end of the scale, some are fore- casting a Fed funds rate still languishing close to zero by end-2015 whereas, at the other extreme, one member is projecting it will have been hiked to 2.75%-3.0%. What happens on the growth and inflation fronts will probably be the deciding factor. We stand by our expectation that the first hike in the Fed funds rate is likely to happen around mid-2015, and that the target range for it will be around 1.0%-11⁄4% by the end of 2015.

Eurozone: deflationary risks and sluggish growth in 2015

Judging by most barometers for the economy, a robust upturn in the eurozone does not look on the cards in the next few months. Markit’s Purchasing Managers’ Index (PMI) for Manufacturing fell in November to 50.1, a score close to signalling stagnation ahead. The PMI sub-index for orders dropped yet again, registering its third month running in the contraction zone.

In tandem, the plunge in the oil price since mid-June 2014 – which works out at 30% expressed in euros – will undeniably have an impact on the real economy. Households and businesses should both benefit from this fall as it should encourage both consumer spending and jobs. In the short term, other factors are also likely to be supportive. Exporters stand to gain from the fall in the euro’s value. Moreover, culmination of the ECB’s stress testing on banks, Targeted Longer-Term Refinancing Operations (TLTROs) and the gradual loosening of lending standards should go some way to fostering a recovery in loans and credit, even though progress is still being curbed by the stubbornly high level of private-sector debt. All things considered, we prefer to continue erring on the side of caution, now projecting GDP growth of 0.8% for 2015.

As for price movements, deflationary pressures look set to extend into 2015. Worse still, falling oil prices may well be good for growth, but they are bad for inflationary expectations. The danger of inflationary expectations softening worryingly has noticeably increased, and the ECB will probably be compelled to adopt even more non-conventional measures, such as buying sovereign debt, and most likely right from the outset of 2015. Political authorities in the eurozone, too, have a crucial role to play. Implementation of structural reforms will become vital to stimulate the already seriously damaged growth potential of economies. Otherwise, the eurozone may be heading for a Japan-style scenario.

China: first cut in benchmark interest rates since 2012

China’s GDP growth slowed to 7.3% y-o-y in Q3 2014, and monthly numbers for October and the initial volley of statistics for November have likewise pointed towards this spell of economic anaemia continuing. After pushing through several carefully targeted softening measures in
recent months, the People’s Bank of China (PBoC) resolved the time was right to send out a much clearer signal. On 21 November, the PBoC lowered its array of benchmark interest rates (including pruning the 12-month lending rate by 40 basis points to 5.6%). The impact of this on the economy is likely to be fairly limited though, so further monetary-easing measures will probably have to be imple- mented in 2015.

The current deceleration in China’s economic growth needs to be put into perspective though. It is part of a progressive process of structural slowdown which should see the Chinese economy’s cruising speed ease from the dizzy rates averaging over 10% between 2000 and 2010 to around a more sedate 5.5% by 2020-2025. The jobs market has, moreover, performed encouragingly this year. In any event, efforts being made by the Beijing authorities to halt the economic slide should bear fruit and growth should level off. We do, however, still expect some further gentle slackening in the tempo of annual average GDP growth to 7.0% in 2015, down from around 7.3% in 2014 and 7.7% in 2013.

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